ttgMB tt g tW O J t 



Principles of Economics 



TAYLOR 




t»!^-ggg" j - jjijxj < r-ji» w«wt»ana a i i i « ri p ii»» B« « MW i fi < i»»ii iii ww -'' 




GopyrighiN 



°_--i£_ 



COPYRIGHT DEPOSHV 



I'^U 



PRINTED FOR THE USE OF STUDENTS IN THE 
UNIVERSITY OF MICHIGAN 



Principles of Economics 



BY 



F. M. TAYLOR, Ph. D. 



ANN ARBOR 

UNIVERSITY OF MICHIGAN 

1911 



Copyrighted By F. M. Taylor, 
1911 



,r^<,' 












AV 



N 



PREFACE. 

As indicated on the title page, this book is 
printed for the use of students in the University of 
Michigan.* Numerous defects, which are of little 
importance while it is in the hands of teachers who 
have more or less shared in its preparation, quite 
unfit it for use by others. 

The book is copyrighted; but any teacher is at 
liberty to reprint any portions which he may con- 
sider useful for his purposes. 

* It is not sent out for review. 



CONTENTS 
Introduction 1 

CHAPTER I 
Preliminary Account of the Existing Economic Order 9 

CHAPTER II. 
Analysis of Production 27 

CHAPTER III. 
The Conditions and Laws of Productive Efficiency 71 

CHAPTER IV. 
Combining Proportions and Product 95 

CHAPTER V. 
The Mechanism of Exchange 131 

CHAPTER VI. 
Some Elementary Propositions with Respect to Money 144 

CHAPTER VII. 
Certain Fundamental Principles of Trade 150 

CHAPTER VIII. 

The Principles Governing the Immediate Determination of 
Prices 166 

CHAPTER IX. 
Normal Price 178 

CHAPTER X. 
Some of the More Important Principles Governing Money 234 

CHAPTER XI. 
Some Special Cases of Production 256 

CHAPTER XII. 
The Present System of Distribution 263 

CHAPTER XIII. 
A Critique of the Existing Economic Order— 325 



INTRODUCTION. 

It is a commonplace of which we need only to be reminded 
that on- of the most characteristic marks of a sentient being 
like man is to have wants, — we might almost say that to feel 
wants and secure their satisfaction is the very essence of living. 
It is hardly less a commonplace that the great majority of our 
wants depend for their satisfaction on our disposal over certain 
material objects or conditions — material goods. Hunger can be 
satisfied only by material food, the need for shelter only by 
material houses, the desire for pleasure-riding only by material 
vehicles, and so on. There are, of course, some wants, such as 
the craving for affection from our fellows, or the religious 
longings, which depend on physchological, or anyhow some sort 
of immaterial, conditions. But these are comparatively few; 
and even they are very closely tangled up with material things. 

But not only is the satisfaction of our wants dependent on 
m.aterial goods, it is further true that most of these material 
goods are obtainable only in exchange for something, — some 
other good relinquished or labor or other form of sacrifice 
supplied. In ordinary language they are said to cost something; 
the economist commonly expresses the same fact by saying that 
they have exchange value— they command a price. Such goods 
are designated generically wealth. They are also called econom- 
ic goods in contrast with free goods, such as air and sunlight, 
which are commonly obtainable without any cost. 

It is a fact obvious to every one that wealth is a thing which 
absorbs a very large amount of our time, thought, and effort. 
We are producing or consuming some of it almost all day long. 
Exchanging it is also a conspicuous phenomenon of every day 
life. Further, a considerable part of our effort is given to 
preserving it from loss or deterioration. Again, our sentiments 
toward wealth are notable facts of our psychic experience. In 
particular, we prize it, attach a significance to it, have a conscious 
realization of its importance to us,— a fact expressed by saying 
that wealth has individual or subjective value. All these and 

1 



PRINCIPLES OF ECONOMICS 

)nany other facts, happenings, relations, connected with zuealth 
or economic goods, we call economic phenomena. These 
phenomena constitute the subject matter of Political Econorriy or 
Economics, just as another set of phenomena constitute the sub- 
ject matter of Chemistry, another set the subject matter of 
Physics, and so on. 

The preceding paragraph brought us to something like a 
definition of economic phenomena. That definition, however, 
would need considerable limitation. Not all the facts, relations, 
and happenings connected with wealth can properly be included 
under economic phenomena. On the contrary, much the larger 
part of them belong, in accepted usage, to other sciences. For 
example, wheat is of course wealth and gives rise to many 
phenomena which are strictly economic. But it also gives rise 
to phenomena which are physical, chemical, botanical, agricul- 
tural, and so on. in short, things are economic only as looked 
at in one special, narrow, way.. In the very strictest sense, they 
are economic only when viewed as possessing value. However, 
such strict limitation of our field as this is impracticable. First, 
there ar.e certain very general phases, of the technological side 
of wealth which would naturally be treated only in some science 
having a more general character than such industrial sciences as 
agriculture, mining, manufacture, and so on; and, up to the 
present, political economy has been this general science. Second- 
ly, a good knowledge of these technological matters, as viewed 
from the economic standpoint, is absolutely essential to an intel- 
ligent study of the most important of the strictly economic 
problems. In fact, we shall find it necessary, as the students of 
other sciences do, to permit ourselves considerable latitude in 
the use of this and other terms. "Economic" will sometimes 
include almost everything connected with wealth. At other times, 
it will be used in the very restricted sense indicated above. In 
still other connections it will have some meaning lying between, 
these extremes.* 



*It is important for the student to learn early in his career that there 
is_ no possibility of defining the limits of economics or any other science 
with absolute precision. Therp are no precise limits to the field of any 
science; and the effort to set up such limits is likely to result in a pedantic 
narrowness quite inconsistent with the truly scientific spirit. It is still 
true, however, that the general character of the phenomena dealt with in 
any particular science can be, and ought to be, fairly well comprehended at 
the outset. 

2 



INTRODUCTION. 

The foregoing discussion of economic phenomena has 
brought out the point that things are economic only when looked 
at in one special way. To emphasize this phase of the matter 
still further, it should be added that there is an economic aspect 
of ^ many matters which the public generally and even many 
economists are wont to look oti as quite remote from the 
economic world. Thus, the ministrations of religion seem 
very far removed from those things which are commonly 
thought of as wealth, such as bread,,- meat, houses, and 
so on. But, in truth, these strongly contrasted things afe 
really in the same class. Bread, meat, houses, and so on have 
an economic character, not because they satisfy very material, 
everyday wants, but because in view of all the conditions of the 
case they have- value — have to be paid for. And just so the 
ministrations of the clergy have an economic character because 
they have to be paid for. Our science, therefore, has to do 
with almost everything high or low, great or little, but only on 
one side of that thing, viz., the one which we call its economic 
side. 

In the second paragraph back, we spoke of economic 
phenomena as forming the subject matter of Political Economy 
just as certain other phenomena form the subject matter of 
Chemistry, still others that of Physics, and so on. We perhaps 
ought to tlote one point of difference between economic 
phenomena and the others alluded to. The latter belong to a 
general group which is in the strictest sense natural, i.e., not 
modified through conditions fixed by men. Economic phenomena, 
In contrast, belong to a group which are in no small degree 
artificial, i.e., influenced by conditions of human origin. Of 
course all phenomena are natural in the broadest sense of the 
term. Thus, it is natural for men to play, hence natural for 
them to invent apparatus and arrange conditions for play, h-cncc 
natural to invent games of cards, form card clubs and so on. 
But, obviously, some things are natural in a fuller and deeper 
sense than are others. Thus a state is more truly a natural 
organization than is a card club. So the family is even more 
truly natural than is the state. Now, many economic relations 
are among the most truly natural and inevitable which can be 
formed; many economic phenomena would be just like those 



PRINCIPLES OF ECONOMICS 

we are familiar with in the same connections, even if we lived 
hke Crusoes or, at the opposite extreme, like a communistic 
society. But, in contrast with these, not a few economic 
phenomena would be very different from what they are now, 
provided certain legal changes were introduced. Thus, the 
amount of wealth enjoyed by many persons would be quite 
different if the state owned all the land. So, it is probable that 
not a few more or less considerable changes in prices would 
take place, if all undertaking of production were left to the 
state. Again, to permit laborers to be owned like beasts of 
burden would surely modify many important economic prenomena. 
The preceding illustrations of artificial economic conditions were 
cases of formal legislation. But it is plain that such conditions 
can be brought about by custom, convention, formal agreements, 
and so on. Thus, a really general boycott of manufacturers 
who employed non-union laborers would be an artificial condi- 
tion of sufficient significance to influence wages and employment 
quite seriously. 

This discussion of artificial conditions quite naturally sug- 
gests a conception which will be of much importance in our 
future study; I mean the conception of an economic order, i.e., 
a system or totality of conditions natural, legal, customary, etc., 
under which economic goods — wealth — are brought into exist- 
ence, distributed, and consumed. Many such economic orders 
might be conceived, though there are only a few principal types. 
But our chief business is with the existing economic order, the 
one at present dominant. Our special task as students of eco- 
nomics is to ascertain the leading facts of this order and the 
principles or natural laws governing economic phenomena under 
this order. 

The preceding will suffice to give the student fairly adequate 
ideas as to the nature of economic phenomena. It surely is 
hardly necessary to remark that these phenomena present prob- 
lems of great interest and importance. For some of these 
problems we shall have to admit that there is not now, and 
perhaps never will be, any complete solution. In not a few 
other cases, the matter requires only careful and patient study. 
At the very worst we shall get a considerable amount of knowl- 
edge which is quite certain and more or less useful. This per- 

4 



INTRODUCTION. 

haps sounds too optimistic, in view of the fact that we often 
hear people who are seemingly quite intelligent declare that there 
are no economic principles, that there is no economic science, 
that in economic matters we could not make the smallest pre- 
diction with any hope of its being fulfilled. Now, this is very 
silly if intended to be taken seriously. Any fairly intelligent 
person can work out on the spur of the moment many examples 
of possible predictions in economic matters which would cer- 
tainly be fulfilled. For example, if there should be a great 
falling off in wheat production next year, the price would cer- 
tainly rise. If, by the introduction of new methods, the cost of 
producing almost any manufactured article were to fall, say, 
fifty per cent. — monopoly being shut out — the price of such article 
would also fall. If the price of aluminum should decline, say, 
fifty per cent., there would doubtless take place a great extension 
of its use in the arts. If the government should begin to coin 
freely both gold and silver, putting only sixteen times as much 
silver into that kind of coin as it does of gold into that kind 
when on the open market an ounce of gold is worth, say, forty 
ounces of silver, the silver would surely get the place of standard 
money while gold would go to a premium and rapidly disappear 
from circulation. And so one might go on. In short, economic 
phenomena, like any other phenomena, are governed by natural 
laws. If the particular group of phenomena in question are of 
such a nature that several almost equal forces are interacting, 
it may be impossible to anticipate the resultant effect, just as 
in complicated natural or physical sciences like physiology or 
meteorology. But, in other cases when only one or two of the 
forces in operation are of any considerable significance, it will 
be comparatively easy to ascertain the probable outcome of the 
totality of conditions. 

On account of the very great practical significance of eco- 
nomic matters to every person, the student is generally tempted 
to make immediate and confident application of every bit of 
economic knowledge which he may acquire. Such procedure is 
not justified in any science ; since, whatever the science one is 
studying, some time must be spent acquiring those most general 
principles the actual working of which, though very fundamental, 
is, after al^, much ebscured by the operation of more superficial 



F'RINCIPLES OF ECONOMICS 

forces. In the case of economic phenomena, this procedure is 
even less justified than elsewhere, because of the great number 
of economic and non-economic forces, which are simultaneously 
acting at any given moment and which make the accurate disen- 
tangling of causes almost impossible. It is, therefore, quite 
important that the student should exercise much self-control at 
this point. In particular, he is urged to suspend final judgment 
on almost all great practical problems, such as free trade, 
socialism, trades unionism, etc., till he takes courses subsequent 
to Course 1, or anyhow till late in that course. This exhortation 
is the more needed because, in the process of trying to secure 
a thorough comprehension of principles, it seems necessary to 
make many applications of those principles to actual problem?. 
If, however, the student will remember that in these applications 
we are concerned only with the economic phase of the matter 
while the practical problem has many other phases, he will real- 
ize that in this connection he should attempt to reach a final 
opinion, not on the whole matter, but only on the economic 
phase involved. 

As already implied in the above discussion, the course upon 
which we are just now entering is primarily intended as a founda- 
tion for later study. It is, therefore, devoted to a severe disci- 
pline upon fundamental principles and their applications. In 
general, our method of procedure is to introduce in a concrete 
way the phenomena needing explanation; then set forth in 
quite formal fashion the principle which embodies the explana- 
tion; follow this with adequate illustration and argument; then 
finish with illustrative problems the solving of which will ensure 
that the student really masters the principle involved. In order 
to get the best results, we would advise that, in preparing the 
lesson, the student should begin by reading the text carefully, 
though not attempting to master it; that he should then under- 
take to solve the illustrative problems, recurring to the statement 
and discussion of principles as he feels the need therefor; and 
that, finally, he should go over the entire discussion once more 
in order to get a better comprehension of the matter as a whole. 
The best results can be obtained from the problems by writing 
out the solution. In doing this, do not rest satisfied with 
categorical answers even when these would seem sufficient; 

6 



INTRODUCTION. 

rather take pains to explain — give reasons for — the conclusion 
reached. Where argument is needed, be careful to put in every 
link in the chain and to put each in its proper place. Cultivate 
clearness and precision of statement. 

Illustrative Problems. 

1. *Tn order to be an economic good — wealth — a thing must 
have utility, — must be capable of satisfying some want." Argue 
for this statement. 

Answer : The distinguishing mark of an economic good is 
the fact that it has value. But no one will set value on a thing 
unless it is capable of satisfying some want of his ; — i.e., unless 
it has utility. Hence to be an economic good, it must have utility. 

2. Is air under ordinary conditions wealth? 

3. Show that in order to be wealth a thing must be appro- 
priable and transferable. 

4. Is the water flowing from a spring by the roadside wealth? 

5. Is an amiable disposition wealth? A hundred tons of 
gold known to be lying on the surface of the moon? A vein 
of coal existing, but not known to be existing, under a Michi- 
gan farm? 

6. "If all the whisky, brandy, gin, and other alcoholic drinks 
in existence were taken out and poured on the ground, there 
would not be one whit less wealth or value in the world than 
before the operation." Is that sound ? 

7. It would cost a good deal of labor to cover the walls of 
the houses on Washtenaw avenue with posters of a circus given 
two weeks ago. Would the result be wealth? What is the point 
to be made? 

8. "A thing may have value and not be useful: e.g., an old 
stone prized by a collector." Point out the error. 

9. When we call a man wealthy we mean that he possesses 
a relatively large amount of this world's goods. Does this 
imply that the possession of the poor man are not wealth? 



CHAPTER I. 

PRELIMINARY ACCOUNT OF THE EXISTING 
ECONOMIC ORDER. 

In the introduction we developed, among other things, the 
motion of an economic order — a totality of conditions under 
which economic phenomena take place; and we explained that 
our study is mainly concerned with the particular economic 
order now existing, — the phenomena displayed under it and 
the natural laws governing those phenomena. Our first task 
is to get a general view of this economic order, to familiarize 
ourselves with its most conspicuous features, before -undertaking 
its more detailed study. 

Section A. The Dominant Features of the Present 
Economic Order. 

1. It is easy to imagine an economic order wherein each 
person produces the very things which he consumes, — bakes the 
bread he eats from flour he has ground from wheat he has 
raised. Such an order might be called an Autonomous economic 
order. But the actual system, as we all know, is far different. 
Most of the goods which each of us consumes are, speaking 
literally, produced by others, while most of those which each 
produces are consumed by others. In short the present order 
is not autonomous but cooperative. Herein is the most im- 
portant single characteristic of that order. 

2. The second important fact about our present system is 
to be found in the peculiar way in which our cooperation is 
effected, brought about. When the word cooperation is used, 
the first thought suggested is that of a system in which we 
act together as the result of an agreement entered into, or of 
authority exercised over us by some outside power. Thus, peo- 
ple cooperate, in getting up a church supper or a picnic, through 
agreement. On the other hand, in the family we have a 
cooperation which is brought about by the authority of one or 

9 



PRINCIPLES OF ECONOMICS 

both of the parents. Such cooperation is conscious, organised. 
This type is present in communistic societies many of which 
have existed in the United States, e.g., the Shakers, Oneida, 
Amana, etc. In contrast, with such conscious, organized, co- 
operation, that of the present order is largely spontaneous, 
unconscious, organic. Each man produces some commodity or 
service and exchanges it for the commodities or services of his 
neighbors. In doing this, he and they really cooperate, but they 
are scarcely conscious that this is true. In fact when they are 
first told that this is the case, the statement almost always has 
to be emphasized very roundly to gain their assent; though 
when once apprehended it seems very obvious. Now the fact 
just brought out is expressed by saying that our cooperation 
in the present order is effected, brought about, through exchange. 
And accordingly we denominate that order as one of Exchange 
Cooperation. 

3. But there is another reason for calling this order one 
of exchange — cooperation. It is pretty clear that, if we have 
any cooperation at all, there must be some way of regulating 
that cooperation. We need more of some things than of 
others. We need certain things so much that it will pay us to 
have them even at the cost of going without some other things 
altogether. Unless there is some guiding, directing, machinery, 
we shall be wasting our resources producing the wrong things 
or the right things in the wrong proportion. Now, in some 
kinds of cooperation this regulating is done, or would be done, 
by authority. This is the case within the family. How much 
time the farmer's boy shall put in weeding the garden, how 
much splitting wood, how much picking up stones, and so on, 
the farmer determines by authority; and such a system prevails 
in the main in the communistic societies to which reference has 
already been made. But throughout most of the present order 
our cooperation is regulated by the same machinery of exchange 
which effects that co-operation, and in the same spontaneous 
way. If too little of anything is produced, prices rise or the 
market expands, profits increase, and so producers of their own 
motion increase output; if, on the other hand, too much of 
anything is produced, prices fall or the market contracts, profits 
diminish, and so producers of their own motion diminish output. 

10 



CHAPTER I. GENERAL SURVEY. 

Again, if the output of some commodity during a particular year 
is exceptionally small, so that consumption all along the line 
needs to be curtailed, this is usually accomplished, not by the 
interposition of the public authorities, but by an automatic 
rising of price which induces almost every one to cut down con- 
sumption of his own motion. So, in various other ways, ex- 
change regulates our cooperation. 

Note : The preceding paragraph has brought out the point 
that regulation, in the existing economic order, is through ex- 
change. This obviously takes for granted the proposition that 
there is regulation of some sort. This assumption, however, 
needs emphasis ; for there is nothing more common, even among 
educated people, than the notion that, save in so far as there 
is conscious interference with the working of things, th:? present 
order is without regulation, is chaos, anarchy, — chance alone 
reigns. Now, this is surely quite contrary to the facts. Eco- 
nomic actions, viewed from' either the individual, or the general, 
standpoint, are regulated actions. They are spontaneously or- 
ganized, correlated, so as to accomplish uniform and regular 
results. There is an ideal, a standard, as to how economic mat- 
ters ought to be managed, ordered, which is probab'y realized 
as fully as any ideal which society sets for itself. Said ideal of 
economic ordering may not be the best, may even be the worst, 
conceivable ; but it is in a high degree realized ; and, so, eco- 
nomic action is not unregulated, chaotic, the prey o chance. 
As to the general soundness of this statement, the student can 
easily convince himself from his everyday experience. The 
more specific and complete argument for it will be supplied as 
our knowledge of the economic order expands in the progress of 
this course. 

We have emphasized the thesis that there is regulation in the 
present order, — that it is not given over to chaos ; we must not 
neglect to disclaim any intention of characterizing the regula- 
tion actually effected as altogether just and expedient. The 
time has not come to go into this matter at all fully ; but even 
at this stage so much should be made clear. No one claims 
that the present system works perfectly, that there are no evils 
which society ought to try to eliminate by authoritative regula- 
tion. That a system wherein regulation was effected automatic- 
ally, spontaneously, wiould work well, without any tincture of 
authoritative regulation, no one would affirm. The most enthu- 
siastic advocates of a let-alone policy have demanded that degree 
of governmental interference which is necessary to exclude force, 
fraud, and violations of contract. Further, as was shown by 
Mill more than sixty years ago, in the actual world, authorita- 
tive regulation goes much beyond this, and does so with almost 

11 



CHAPTER I. GENERAL SURVEY. 

universal approval. Now, it surely would be very silly to claim 
that this policy has been carried just as far as it ever ought to 
be. There surely are left not a few places where spontaneous 
regulation fails to attain good results ; and it surely is possible 
that at some of these points authoritative regulation would do 
better. Finally, it is entirely possible that in the end organized 
society wi-1 come to look on the present system of regulation 
as so greatly inadequate that it will be constrained to adopt a 
system of complete authoritative regulation like communism, or 
one in which such regulation is only a little less complete, i.e., 
socialism. But even so, even admitting the final unbearableness 
of the present order, we should still have to insist that this 
order is not chaotic, anarchic, — ^that it is a regulated and a 
rationa ly regulated, order, though one in which the process of 
regulation is automatic. 

4. We have seen that the present economic order is one 
wherein men cooperate and wherein their cooperation is effected 
and regulated through exchange. The next most important 
characteristic of the present order is individual initiative. It is 
quite possible to conceive a system of cooperation which, in- 
part at least, is effected and regulated through exchange, but 
in which initiative is left to society as a whole, government. 
This would be the case under socialism as it is commonly ad- 
vocated. In such a system the state would be the sole farmer, 
miner, manufacturer, merchant, et al., i.e., the state alone would 
undertake to produce things, putting all individuals into the 
position of employees. But it would enter into relations with 
these individuals under the conditions of free contract, buying 
their services in the open market. Further, it might, probably 
would, pay for these services prices determined under the free 
working of the laws of value. So, in determining what, and how 
much, should be produced, it would probably be guided by the 
fluctuations of freely determined prices, (For example, if the 
price of some particular thing went down, the government would 
take this as a warning to diminish the production of that thing.) 
But, while such a system would, like the present, be a system 
of exchange cooperation, it would differ radically in leaving 
all initiative to the state; whereas, in the present order, initia- 
tive is mostly, though not entirely, the business of the individual, 
— persons who have the means and think they see a chance to 
obtain profits set about producing wheat or iron or chairs or 
dishes, etc. Accordingly, to give something like a complete 

12 



CHAPTER I. GENERAL SURVEY. 

characterization of the present order in its most general fea- 
tures we have to say that it is a system of Individual Exchange 
Cooperation, 

5. The preceding discussion has laid much stress on the fact 
that the existing order is cooperative. In thus characterizing 
that order we almost necessarily say that it is one wherein 
specialization prevails, i.e., one in which different persons 
devote themselves to doing different things, — one man makes 
shoes, another clothes, another bread, and so on. Doubtless 
there are occasions when homogeneous cooperation, i.e., co- 
operation of persons doing the same sort of things, is of decided 
advantage, e.g., a barn raising; but cooperation would have 
very slight significance compared with what it now has did it 
not also prevail in the form of heterogeneous cooperation, i.e., 
a cooperation in which the different participants do different 
things. Further, the successful working of heterogeneous co- 
operation would require that the differentiation of tasks should 
be more or less permanent, — each one should make a practice 
of doing one sort of thing only. That is, we should have to 
have thorough-going specialization. And of course this is what 
we do have in the present order. Each devotes himself to doing 
one sort of things, acquiring in this way extraordinary skill 
and efficiency. Further, the same rule of specialization is ap- 
plied to the instruments used in production, the tools and 
machines, — till more and more each is fitted for one very small 
job. Finally, the same idea is carried out with respect to land, — 
one district being devoted to celery, another to onions, another 
to citrous fruits, and so on. 

Illustrative Problems. 

1. Give some examples of automonous production from every- 
day experience. 

2. "Robinson Crusoe, on his far-away island, had neither 
trade nor commerce. Except for the supplies that he recovered 
from the wreck of the ship, he obtained his food from the plants 
that he cultivated and from the wild animals that he killed. 
His clothing was made from the skins of goats ; his table and 
his chairs were the work of his own hands. Even his shelter 
was constructed of the stone and wood that he found on the 
island. Is he had more of one product that he needed he could 
not exchange it for other necessary articles. If provisions, 
utensils, clothing, tools, or metals were lacking, he could not 



PRINCIPLES OF ECONOMICS 

buy them. He^ was by turns hunter, fisher, tanner, farmer, 
miller, baker, blacksmith, and carpenter." 

{ The above is the opening paragraph of a book on Commercial 
Geography. It seems intended to suggest the significance and 
importance o'f commerce by setting forth the disadvantages of 
isolation such as Crusoe's. Put the gist of the matter in a 
single sentence. 

, ^3. "In the main, industry is organized in a spontaneous 
way. Men choose such occupations as they like, and when there 
are too many of them in one gfoup and too few in another, the 
automatic working of economic forces moves them from the 
former into the latter," Explain and illustrate the last clause of 
that sentence. 

.4. "The great advantage of foreign trade is in furnishing a 
market for our surp'us products which would otherwise go to 
waste." This surely is only a minor advantage of foreign trade. 
Give something better. 

. 5. If the potato crop of a communistic society which had no 
commerce with other communities were to fall off one-half, how 
would they regulate the consumption of potatoes for the follow- 
ing year? How is it done under the present, order? 

6. "It will never pay us to import anything which we our- 
selves can produce." Show that this proposition is erroneous. 

Section B. Principal Advantages of Cooperation, Looked at 
from the Standpoint of Individuals. 

It is probably unnecessary to spend much time arguing that 
cooperation in economic matters will surely prove far more 
efficient than independent action. But we can hardly pass the 
matter without pointing out two or three of the most con- 
spicuous advantage of such cooperation. 

1. Cooperation enables the individual to enjoy not a few 
goods which ^otherwise .he could not enjoy at all because he 
could not prodiice them. Thus, (a) Homogeneous cooperation 
makes possible results which no person acting aloi^e can bring 
about, and which, therefore, the individual could not enjoy were 
it not for cooperation, (b) Heterogeneous cooperation — doing 
different things and exchanging the products — often enables the 
individual to get and enjoy goods which he, anyhow, can not 
produce, whether acting alone or with others^ and which, there- 
fore, he could not have at all were he dependent on himself 
entirely. Thus some articles can be produced in only a few 
place's. Some services can be performed by only a few persons. 

14 



CHAPTER I. GENERAL SURVEY. 

A literally complete exclusion of cooperation would mean death 
to not a few persons. 

Note : Put in a slightly different way, cooperation enables 
every one who has any capacity, however small, for doing things 
which people want done, to utilize such capacity in getting the 
things he needs, even though his powers are inadequate to per- 
form a hundredth part of the tasks which he himself needs to 
have done every day. 

2. Cooperation enables the individual to enjoy a far larger 
quantity of those goods which he himself could produce. Special- 
ization enables both the farmer and the carpenter to become 
more productive than if each worked at both trades. Conse- 
quently, each, in cooperating with the rest, gives, and so gets, 
more goods than he would if he worked by himself. 

3. 'Cooperation enables the individual to enjoy a far better 
quality of goods than otherwise. Specialization enables each to 
produce better goods than if he tried to produce all kinds. 
Through exchange^cooperation each gets the benefit of this 
improvement. 

Illustrative Problems. 

1. Name five or six commodities or services which you 
eould not have at all if you did not cooperate in some measure 
with other persons. 

2. Name three or four economic goods which you could not 
have at all if you did not cooperate with persons in some other 
part of the world. 

3. Name two or three kinds of goods which could be pro- 
duced in your neighborhood but which you obtain more cheaply 
through cooperating with the people of other districts, 

4. Might it pay you to buy from other districts things 
which you eould produce almost as well as the things you do 
produce? 

5. Give two or three illustrations of how a specialized tool 
naturally does a better job in respect to quality than a non- 
specialized one. 

6. "During 1904 more ships were built on the Clyde than in 
the whole of the United States. This fact is creditable to Great 
Britain but not to us." Show that the fact stated is probably 
not discreditable to the United States. 

7. The people of the Copper Country in Upper Michigan 
mostly buy their furniture and dry goods from other parts of 
the country. Does this prove that they could not produce good 
furniture and dry goods at home? If not, what does it prove? 

15 



PRINCIPLES OF ECONOMICS 

Section C. Some Formal Principles Based on the Above 
General Account of the Present Economic Order. 

A rather notable fact in this age of general education and 
enlightenment is the continued acceptance by a great majority 
of persons, not professional economists, of quite erroneous no- 
tions with respect to several familiar and not very difficult 
matters. In fact, one can scarcely run through a current news- 
paper or popular magazine without coming upon fallacies which, 
as the economist looks at it, were fully disposed of by Adaiii 
Smith almost a century and a half ago. This prevalence of 
unsound doctrine is particularly troublesome and dangerous in 
the United States because of the fact that the majority of the 
people have the power to rule and commonly assert that power 
when economic problems are up for consideration. Accordingly, 
one of the m.ost important tasks of the student of Economics 
is to train himself in the art of detecting the fallacies which 
lurk in popular errors. Further, this task confronts us at the 
very outset of our course ; for some of the most widespread 
of popular errors with respect to economic questions are con- 
nected with matters already brought out in the above general 
account of the present economic order. We will, therefore, 
at once set about formulating principles and applying them to 
popular errors. 

Caution : At the very beginning of this kind of work, how- 
ever, it is important to warn the student of certain dangers 
which are apt to beset him in dealing with these fallacies, as 
well as in making any other application of economic principles. 
The special task of an elementary course like this is to insure 
the clear apprehension and firm mastery of fundamental prin- 
ciples. We therefore put those principles in very definite form 
and illustrate them with hypothetical problems of so simple a 
character that their rigid, dogmatic, application is entirely justi- 
fied. It should be remembered, however, that almost all the 
problems which real life presents are characterized by numerous 
and complex conditions. In actual life, therefore, the immediate 
and hasty application of economic principlt^ is highly dangerous. 
Everything taken into account, a given line of policy may be 
justified, although the economic argument commonly given for 
it is quite ridiculous. The student must, therefore, be very 
cautious in applying principles to concrete cases — holding himself 
cpen to receive light from all sources and looking carefully for 
conditions which neutralize those that would influence him as an 
economist to decide for or against a given measure. In short, 

]6 



CHAPTER I. GENERAL SURVEY. 

he must be careful not to develop into a doctrinaire, one zuho 
insists on applying principles which abstractly speaking are 
sound, without regard to the varying conditions of real life. 

One of the first generalizations from the nature of the pres- 
ent order which we have to lay down, brings out the fact that, 
generally speaking, each gains from the increased efficiency 
of his neighbors. This comes pretty close to being an evident 
corollary from the proposition that we do cooperate in economic 
matters. As long as we cooperate, act as one, in producing 
goods, an increase in the efficiency of the persons producing 
one commodity would surely increase the total product of the 
group and, so, would naturally be expected to bring advantage 
to the other members of the group as well as to those whose 
efficiency had increased. It might, however, be argued that, 
while the aggregate product of the group would surely be in- 
creased, this would not necessarily be of any advantage to the 
other members of the group, in that the increase might all 
go to the persons whose efficiency had increased. Now, the 
full answering of this objection depends on a knowledge of the 
principles of price or value which we do not take up till quite a 
little later in our study. Still, it will not be difficult to antici- 
pate that discussion sufficiently to satisfy the student's mind in 
regard to the general point. (1) If under free competition 
we have increased efficiency among the producers of a given 
commodity, no change taking place among other commodities, 
then the exchanging rate between the first commodity and all 
the others will alter in favor of the others, i.e., each unit of 
any of the others will buy more units of the first commodity. 
(2) Since, by hypothesis, no change has taken place among 
producers of other goods, the exchanging ratio among these 
goods will not have altered; i.e., each unit of any one of these 
other goods will buy as many units of any other of them as 
before. (3) Consequently, any producer of one of the other 
commodities will find himself able to buy with his own product 
more units of the product in respect to which efficiency has 
increased while buying no less of other products, that is, 
he will have gained from the increased efficiency of another 
set of producers. 

Caution : It must not be imagined that the producers whose 
efficiency has increased make no gain. Each unit of their 

17 



PRINCIPLES OF ECONOMICS 

commodity buys less; but they have more units to buy with, and 
usually this will mean an increased total of other goods. 

Formulating the point brought out in the foregoing dis- 
cussion, we have the following 

Principle. The present order, being a cooperative one, each 
person or community tends to gain from any increase in the 
economic efficiency of other persons or communities with whom 
or with which said person or community maintains economic 
relations. 

A second matter on which we need thus early to lay down 
a formal principle is the function of trade, exchange. There is, 
indeed, almost no other phase of economic matters on which 
popular opinions are so much astray. In the minds of a few 
persons, all trade whatever is illegitimate. To a much larger 
number, this is anyhow true of some kinds of trade. In the 
view of a majority of persons, probably, trade, if legitimate at 
all, is surely unproductive in any proper sense of words. Many 
persons who do not go quite so far hold this opinion with 
respect to some forms of trade. Now, it is hardly necessary to 
say that, if the account which we have given in this chapter 
of the general features of the present economic order is sub- 
stantially sound, all these adverse judgments about trade, ex- 
change, are quite untenable. Trade in general, and presumably 
all kinds of trade, are legitimate, — play a vital role in economic 
affairs. If we understand by the word productive that the 
operation so characterized fulfils a condition essential to the 
satisfying of our wants, then trade, in some form certainly, is 
productive. These points may be formulated in the following 

Principle. Under the existing economic system, exchange 
(trade, commerce) plays an essential part in that it makes pos- 
sible economic cooperation and specialization — it supplies the 
process, or system of processes, whereby cooperation is effected 
and regulated. 

Let the student argue for the two points:* (1) Ex- 
change is necessary to effect, bring about, cooperation. (2) 
Exchange is necessary to regulate cooperation. Reflect on 

*Tn economics, as in mathematics, it is very important that the student 
should learn to think for himself. Just as far as possible, therefore, I 
shall leave him to make for himself the argument needed under each prin- 
ciple. In the case before us surely this plan is feasible. 

18 



CHAPTER I. GENERAL SURVEY. 

such questions as these: (a) What good would the baker get 
from making 500 loaves of bread, without exchange? (b) Of 
what use to farmers or ultimate consumers of wool is the 
local wool buyer? (c) Is there any need for the larger buyers 
in central points like Denver, Chicago, New York, Boston? 
(d) Suppose there were a big shortage in the cotton crop, 
say 40 per cent, and no rise in price took place, what harm 
would probably result? 

Corollary 1. Exchange operations, viewed as processes nec- 
essary to consunmnating our economic cooperation, are pro- 
ductive operations, and those engaged in such operations are 
producers — productive and producers being employed to indicate 
that the operations and persons in question supply conditions 
essential to the satisfaction of our wants. 

This proposition so plainly follows from the principle that 
no argument is needed. 

Corollary 2. Exchange operations, viezved as processes 
whereby our cooperation is regulated through price, are pro- 
ductive operations and persons engaged in such operations are 
producers. 

This proposition, again, follows quite directly from our prin- 
ciple. However, it may need some little comment. Some persons 
are prepared to admit that mercantile operations are productive 
in so far as they are devoted to buying from producers and 
selling to consumers, though the same persons would be dis- 
posed to deny the productivity of such operations, in so far as 
they involve the fixing of prices. But the principle tells us that 
exchange, trade, is responsible for the proper regulating of our 
economic activity and that this part of its work is largely done 
through changes in prices. It follows, then, that exchange 
operations, viewed as price-fixing operations, are essential to . 
our economic efficiency and so are productive operations. 

Illustrative Problems. 

1. "Give the farmer a parcels post to begin with. Let him 
send his dozen eggs or his pair of chickens direct to the man 
who wants to eat them, or at least to the retail merchant. Cut 
out the commission merchant, the wholesaler, and a few other 
of the city parasites that live on the farmer." — New York Even- 
ing Journal. 

(a) Suppose yourself to be a farmer living in the neighbor- 

19 



P^RINCIPLES OF ECONOMICS 

hood of Ann Arbor, and point out some advantages you would 
derive from selling your butter to the grocers and your chickens 
to the meat men rather than to consumers. 

(b) Suppose yourself to be a fruit grower in Western 
Michigan, dependent for your market chiefly on Chicago, and 
point out some disadvantages which you would suffer if 3 ou 
tried to sell your grapes, peaches, etc., by parcels post to the 
ultimate consumers in Chicago and its vicinity, rather than to 
commission merchants. 

(c) Show that these facts are inconsistent with the notion 
that commission merchants, wholesalers, et al.^ are "city par- 
asites." 

Note : There is of course much to be said in favor of a 
parcels post ; and it is always possible that the number of 
middlemen should become needlessly large so that some of them 
may fairly be viewed as parasites. But such a characterization 
of the class as a whole is quite illegitimate. 

2. "Internal commerce does not increase the wealth of a 
nation since it only transfers goods from one person to an- 
other." Criticise. 

3. In the natural course of events it often happens that a 
country loses some portion or the whole of its market in some 
particular country. When this happens or is anticipated, public 
men are apt to speak as if such a result involved almost irreme- 
diable disaster. Doubtless it would mean some loss, but by no 
means the amount which people seem to imagine. Explain pre- 
cisely what would be the nature of the injury to us, if our for- 
eign trade should fall off by a considerable amount. Suppose 
our foreign market showed a permanent net shrinkage of 200 
millions of dollars per annum would this mean that our yearly 
income would be 20O millions smaller? If not just what would 
it mean? 

4. A certain Detroit grocer who is a Socialist and no longer 
young often expresses regret that the obligation to support a 
family compels him to continue in an occupation which makes 
him a "parasite" — one who lives on others, consumes without 
producing. 

Show with details that he probably is not a parasite. 

5. "A first-class illustration of the absurdity and wrong of 
the present order is furnished by the case of a plumbing firm. 
Such a firm does little, if anything, more than act as a middle- 
man between the actual plumbers and householders. But it 
pays the former at the rate of, say, 30 cents an hour for their 
services, while it charges householders 60 cents an hour for 
those services. Here you have a plain case. Either the firm 
underpays the laborers or overcharges the householders; and 
in either case it gets something which it has no right to. There 
is no other alternative." Discuss the above. 

20 



CHAPTER I. GENERAL SURVEY. 

6. In connection with nearly all of the great staple products, 
such as wheat, corn, oats, cotton, wool, etc., there is commonly 
maintained a peculiar sort of central market, usually known as 
an exchange or on the continent of Europe as a bourse. The 
most distinctive characteristic of such markets is that the major 
part of the trading carried on in them does not seem to have 
any part in passing the commodity on from the original pro- 
ducer to the ultimate consumer, but rather is a trading backwards 
and forwards, to and fro, between the members of the same 
market, leaving the commodities just where they were, and 
apparently having no object save the getting of a profit — which 
is often compared to the gains of the gambler. By not a few 
intelligent and able men, such trading is characterized as quite 
illegitimate. The economist, however, insists that it performs 
two or three quite important functions. One of these is said 
to be insuring that the commodities in question shall have just 
the right prices. Try to think of some reasons for believing that 
a great speculative market with the most elaborate machinery for 
getting the very latest information in respect to the state of the 
crops, the stock on hand, the changes in demand, and so on, 
would tend to insure that prices should be what the needs of 
the case call for. 

7. A recent writer (not an economist), in setting forth the 
wastes of competition, has maintained, though with little or no 
argument, that, in so far as exchange means nothing more than 
that different producers bring each his product to a common 
store and take away each an equivalent, such exchange is nec- 
essary, legitimate, productive ; but, in so far as exchange means 
what he quite improperly calls barter, dickering over and finally 
settling on a ratio of exchange between what one brings and 
what he takes away, it is not necessary or legitimate or pro- 
ductive. Show that such a doctrine is quite untenable. 

8. The general account of the existing economic order 
which has been given in the present chapter furnishes one of the 
most fundamental objections to the maintenance of a protective 
tariff; i.e., a tariff intended to hinder our buying goods from 
other countries. Explain that objection. 

9. "If the wheat crop of the world should fall off one-half 
next year, a rise in price would then be of great social advantage, 
in fact, almost indispensable." Explain. 

10. From the Congressional Record for May 17, 1909 : "Mr. 
Aldrich: Assuming that the price fixed by the reports is the 
correct one, if it costs 10 cents to produce a razor in Germany 
and 20 cents in the United States, it will require 100 per cent 
duty to equalize the conditions in the two countries . . . And, 
so far as I am concerned, I shall have no hesitancy in voting 
for a duty which will equalize the conditions. 

21 



PRINCIPLES OF ECONOMICS 

If it was necessary to equalize the condition, .... I would 
vote for 300 per cent as cheerfully as I would for 50."* 

To what sort of an economic system would such notions, if 
logically carried out, inevitably lead? 

Section D. A More Specific Account of the Forms Which 
Cooperation and Specialization Assume under the Present 
Order. 

In our general account of the cooperation prevailing under 
the present order, no attempt was made to go into the matter 
at all specifically. In fact it was vaguely assumed that all co- 
operation takes a form wherein each producer makes some one 
thing from first to last, — starts it and finishes it ready for the 
consumer, e.g., the farmer supplying potatoes. This sort of co- 
operation we might distinguish as primary cooperation or 
primary division of occupation. But every one knows that co- 
operation commonly goes much further than this. Almost no 
one carries from the beginning to the end the processes neces- 
sary to the production of a particular consumption goods. The 
work of the baker must be preceded by that of the miller and 
the farmer. So, the work of the shoemaker must be preceded by 
that of the tanner and the stock farmer. Further, between each 
producer in the series and his successor, must come the dealer, 
the middleman, to effect the necessary transfer of the product be- 
tween the independent producers. In addition, the various mem- 
bers in the original series make much use of the products and 
services of producers in other series. Thus, the dealers who 
transfer the hides from the stock-farmer to the tanner make 
use of the services of various producers outside the series, 
especially those engaged in the transportation business. Tanners 
again use coal produced by another group, also bark, and 
various chemicals. In like manner, shoemakers use thread, 
bristles, needles, machinery, cloth, etc., etc., which they obtain 
from other classes of producers quite outside our original series. 
Here then we have division of occupation within division of 
occupation. We might call it secondary cooperation or second- 
ary division of occupation. 

But, in an economic society having any considerable degree 
of development, cooperation and specialization go still further 



*Quoted from the Quarterly Journal of Economics for November, 1909. 

22 



CHAPTER I. GENERAL SURVEY. 

than has yet been brought out. Even in the last case we were 
thinking of undivided industrial units, though each was devoted 
to providing only some one element in the ultimate product; 
e.g., a stock farm devoted to raising cattle, a tannery occupied 
preparing hides for leather, and so on. But we all know that 
there is specialization within each industrial unit. The tannery, 
which as a whole produces leather, has some men scraping hides, 
some attending to the curing of the hides in the various baths, 
some staining, some finishing, some keeping books, some writ- 
ing letters, etc. Obviously this sort of specialization is also of 
very great significance. Writers have sometimes distinguished it 
from the kinds already considered as Division of Labor; while 
those are called Division of Occupation. 

But we have not yet brought out the full extent of co- 
operation and specialization under the present order. The spe- 
cialization thus far considered more especially grows out of 
the differences in the physical or technical operations to be per- 
formed, as just seen in the case of tanning. But there are deeper 
differences among the functions, processes, factors, involved in 
production. Production requires that some man possessing more 
or less wealth should assume the responsibility of production; 
it requires that he should have land upon which to work; 
it requires that he should have laborers to perform the different 
tasks ; it requires that he should have materials, tools, and ma- 
chines to assist these men. In short, to use the more technical 
language of Economics, there must be at least three factors of 
production : land, labor, and capital. As the last of these comes 
to the work in two different relations, controlled by two dif- 
ferent sets of persons, we have in reality something like four 
groups of productive agents engaged in every industry, namely: 
landlords, laborers, capitalists proper, those who supply the cap- 
ital needed in production, and entrepreneurs, those owners of 
wealth who assume the responsibility of production. Here, man- 
ifestly, we have a deeper sort of cooperation and specialization 
than anything yet considered. This particular kind of coopera- 
tion and specialization now under consideration, I will for the 
lack of a better term designate as functional cooperation. We 
at least ought to realize the existence of such a system, even if 
we seldom have occasion to make special reference to it. 

The student should further note that the development of this 

23 



PRINCIPLES OF ECONOMICS 

functional specialization and cooperation brings in its train new 
cases of specialization analogous to the simpler forms already 
considered. Thus, the more completely the furnishing of cap- 
ital has become isolated from taking the responsibility of pro- 
duction, the more there have developed institutions for dealing 
in this capital. Prominent among such institutions are com- 
mercial banks, savings banks, trust companies, and so on. 

Note : At this point it seems desirable to remark on one 
very important general result of the great extremes to which 
specialization is carried in the present order, viz., that this fact 
gives to the existing system an extraordinary complexity which 
is very confusing to the general public and not a little so to 
the trained thinker. It is often difficult to isolate the precise 
function played by a particular business ; and people who form 
hasty conclusions are very apt to deny the existence of such a 
function, to affirm that the business in question plays no legiti- 
mate part, so that those who pursue it are mere parasites upon 
society. The student should studiously avoid this practice. In 
fact, he will do well to assume at the outset that every occupa- 
tion, not catering to human vice, plays a real and legitimate 
role in the total conduct of economic affairs, — is doing some 
one of the numberless things necessary to be done if we are to 
attam the highest economic efficiency. 

To summarize this discussion: The present economic system 
presents itself to us as one wherein we have a vast complex of 
different industries, mining, stock-raising, farming, manufactur- 
ing, transporting, etc., each concerned in the production of some 
com.modity at one or another stage of completion, while, within 
each of these industries, different functional groups of pro- 
ductive agents, entrepreneurs, capitalists, laborers, and land- 
lords, are cooperating, and while, finally, this vast industrial 
complex is brought together, is held together, and is regulated 
through exchange, — buying and selling. 

Illustrative Problems. 

1. On South University is a little shop which does more or 
less making of shoes to order; the uppers, however, are bought 
ready-made from some large manufacturing house. This last 
fact illustrates either division of labor or division of occupa- 
tion. Which ? 

2. It is not uncommon to group together the principal 
industries from which are derived the ultimate materials out 
of which, and with the aid of which, goods are made, e.g., 

24 



CHAPTER I. GENERAL SURVEY. 

copper, coal, wheat, under the designation Extractive Industries. 
Enumerate the chief subdivisions of this group. 

3. How would you describe the difference between the ex- 
tractive industries and the manufacturing? 

4. Suppose that in a certain farm family the father manages 
the outdoor work, doing much of the heaviest of it; the wife 
cooks and keeps house; the daughters wash dishes, set the 
table, etc.; and the boys bring in wood, feed the chickens, hunt 
eggs, pick berries, etc. What is illustrated here, division of 
occupation or division of labor? Explain. 

5. When one concern makes bicycle frames, another rims, 
another spokes, another tires, etc., etc., while a bicycle factory 
buys the different parts from the different concerns alluded to 
and makes them into a completed bicycle, it is plain that the co- 
operation of these different producers is brought about and reg- 
ulated through exchange. If, however, all these concerns were 
to be consolidated into one which made bicycles from the ground 
up, cooperation would then be effected and regulated by author- 
ity. Show that there would still be in the establishment much 
functional cooperation effected and regulated through exchange. 

6. "The whole machinery of buying and selling is simply a 
convenient means of combining effectively the various factors in 
production, and of assigning the appropriate shares of the 
product to those who have claims upon it.'' 

That sentence was written for advanced students of eco- 
nomic theory; still we are probably prepared to get the main 
points of it. Explain what you understand it to mean. 

7. There is some propriety in speaking of commerce, trade, 
as an a l-pervasive kind of economic activity, entering into pro- 
ductive processes at innumerable points. 

Explain and illustrate. 

8. As social and industrial development advances, special- 
ization, and so coperation, goes further and further. Try to 
think of several examples of specialization carried to a notable 
degree. If possible, choose cases from your own experience. 

9. It is often said that capital and labor are each indis- 
pensable to the other. Illustrate the point. 

Section E. Some Necessary Legal Conditions of the Present 

Economic Order. 

A very little reflection will show that the working out of an 
economic order such as has been described above and is now 
existing necessary involves the maintenance of various legal 
conditions, particularly various rights. Here follow some of the 
most important of these rights. 

25 



PRINCIPLES OF ECONOMICS 

1. Individual Property, not only in final products, but also 
in factors of production, land, ultimate raw materials, tools, ma- 
chines, etc. By the right to property is meant the right to 
exercise substantially exclusive control over the disposal of any 
thing — the right to use that thing oneself and to hinder others 
from using it. To some degree the right of individual (private) 
property would be necessary even under communism — e.g., each 
would certainly have to have exclusive disposal over articles of 
food. But, under our present system, it must go much further 
than this. We could have no private initiative in the producing 
of commodities, unless private persons were allowed to own the 
goods from which, or with which, commodities are produced. 

2. Industrial Freedom. Since cooperation in the present or- 
der is not consciously organized but works itself out through 
the spontaneous action of individuals, freedom of action for in- 
dividuals is plainly an essential condition. This takes various 
forms, of which the following are the most important : (a) 
freedom of initiative, the right to start enterprises without in- 
terference, (b) freedom of competition, the right to strive for 
the same prizes as others without interference, and (c) freedom 
of contract, the right to enter into economic engagements with 
other individuals without interference. 

Illustrative Problems. 

1. Distinguish property in a thing from possession of it. 

2. Illustrate in detail the proposition that the working of 
the present economic system necessarily involves permitting 
private persons to own the means of production. 

3. Show that it is inconsistent with the general plan of "the 
present order to permit producers to form monopolistic com- 
binations. 

4. It is often said that private initiative is much more pro- 
gressive than public initiative wpuld be. Explain in simple lan- 
guage what is meant. 

5. Argue for the proposition that we could not have an 
efficient industrial system without a pretty strong government. 

6. Illustrate the proposition that the working of the present 
economic order involves freedom of contract between indi- 
viduals. 



26 



CHAPTER II. 

ANALYSIS OF PRODUCTION. 

It needs very little reflection to convince any one that prac- 
tically all economic goods of the sort that are put directly to 
the satisfying of wants, as also the great majority of inter- 
mediate goods, are produced — result from the action of men. 
It is hardly necessary to say, then, that one important topic of 
economic study is Production, — the means, processes, and con- 
ditions, by which, and under which, men bring economic goods 
into existence. We must, however, note at the outset that 
economics does not undertake an exhaustive study of produc- 
tion. Much the largest part of what might be said under such a 
head is relegated to technical sciences and arts such as Mining, 
Engineering, Agriculture, Mechanics, and so on. Economics 
limits its study of production to certain most general aspects 
of the matter — especially such as have very close relations to 
the problems of value, since, these form the heart of economic 
science. 

Section A. The Economic Factors of Production. 

It is evident on the least reflection that to produce wealth, 
economic goods, involves the combined operation of various 
elements or factors. We raise potatoes with the aid of land, 
fertilizers, rain, sunshine, tools, etc. One of our first tasks is 
to isolate the different factors, decide what ones are economic, 
group them into classes, and so on. In doing this we will 
analyze commodity production, which, being more complicated 
than service production, fairly covers both cases. 

1. Surface Account of the Elements or Factors Involved in 
Commodity Production. 
Let us begin by setting down everything we can think of 
which seems necessary to the production of some manufactured 
article, (a) First, plainly, we must have the decision, willing, 
of some person to produce ; — this is more or less separable from 

27 



PRINCIPLES OF ECONOMICS 

the labor, land, etc., necessary, as seen in actual, everyday, 
production, (b) Next comes a place for the producing process, 
which naturally breaks into (1) position on the earth's surface, 
(2) a specially prepared spot of ground', and (3) a building 
or buildings, (c) Materials, wood, iron, steel, etc., are neces- 
sary; and these, which are themselves (1) produced materials, 
must have been made out of (2) ultimate materials, (d) Labor, — 
efforts, physical or mental, made by human beings, — is of course 
indispensable, (e) Tools, instruments, must be available, (f) 
Machines, complex tools more or less automatic in character, 
will commonly be used, (g) Behind these machines will be 
prime-movers, sources of power such as the steam engine, or 
water power, (h) In some cases these will require fuel or feed 
(i) All the time we shall be using, consciously or unconscious- 
ly, unappropriated natural powers and materials, e.g., gravitation, 
heat, light, moisture, air, etc. (j) Finally, producing anything 
takes time; further, the producing of some things takes more 
time than the producing of other things; and, most of all, the 
producing of things in some zvays, requires more time than 
producing them in other ways, though, once the longer way is 
started, we can produce better and faster by that way. In 
short, production, to be carried on in accord with our best 
interests, requires that we should have the power to dispose of 
time, in the sense of being able to choose a procedure which 
requires waiting as well as working. (Read pages 29 and 30 
of the Readings and show that the use of the more efficient, 
but also more roundabout, methods involves the possession of 
waiting power.) 

For the sake of definiteness, let us make a list of these in 
tabular form. 

(a) Conscious willing to produce, — assembling the elements, 

etc., — assuming the responsibility of having production 
go on. 

(b) Place. 

(1) Position. 

(2) Prepared land. 

(3) Buildings. 

(c) Raw Materials. 

(1) Produced Raw Materials. 

(2) Ultimate Raw Materials. 

28 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

(d) Labor. 

(e) Tools. 

(f) Machines, 

(g) Prime movers. 
(h) Fuel or food. 

(i) Nature's Powers or Materials not Embodied or con- 
trolled through land or some of the things above 
enumerated, 
(j) Time. 
2. The List of Elements or Factors of Production Revised and 
Grouped on the Basis of a Deeper Analysis. 
It is hardly necessary to say that no thoughtful person would 
be satisfied with the above strictly surface account of the factors 
involved in production. Some deeper analysis and grouping is 
surely needed. 

(a) In the first place, the elements grouped under (i), those 
powers or materials of nature which are not controlled through 
land or machines of prime movers, e.g., the air. — nitrogen in the 
air, moisture, etc., though necessary to production, are not 
accounted economic factors at all, for the reason that they are 
not controllable or appropriable, therefore, do not have value, 
therefore do not belong in the economic field. Elements of 
this class are physical or technical factors of production but not 
economic factors.* 

(b) Again, land which is actually being used in production 
is not necessarily a true economic factor. In partially settled 
countries, anyhow, there will often exist a state of things 
wherein some of the land actually in use is no more desirable 
than plenty which is not in use and has no value because of 
this abundance of its kind of land. Under these conditions, the 
particular piece of land actually being used is not an economic 
factor. This of course does not mean that the potatoes or 
wheat raised on the land in question could be raised without 
land; but merely that, under the circumstances, none of the 
product is credited to the land, since plenty other pieces just 
as good could be substituted for this particular piece without 

*Notice that a thing may be a technical factor but not an economic 
one. The converse, however, is not true. Nothing can be an economic 
factor which is not first a technical factor. If any element is essential 
to the result, it is a technical factor. If, in addition, it comes into the 
economic field as a thing which has value, it is an economic factor. 

29 



PRINCIPLES OF ECONOMICS 

costing anything, and so the land factor is in this case virtually 
a free good like the air or the nitrogen or the moisture which 
figured in the preceding case.* 

(c) The preceding two paragraphs have thrown out from the 
list of economic factors some elements of natural origin, air, 
nitrogen, and even land under some conditions. But some of 
nature's contribution are surely economic. The ultimate raw 
materials, (c) (2), often have value, because relatively scarce, 
and so must be accounted economic factors. So, land, as posi- 
tion on the earth's surface, (b) (l), though not necessarily an 
economic factor, is usually such, being scarce and having value. 
This factor we might call "nature." But more usually it is 
designated land, meaning, remember, the original, unproducible, 
indestructible, earth, — including ultimate raw materials, — together 
with such produced elements as, under various conditions, come 
to behave, in the determination of values, as if they were an 
original part of the earth. 

(d) Labor, the element numbered (d) in our table, is ob- 
viously a technical factor in production, — without it production 
can not go on. Further, as we all know, it is also an economic 
factor, — it has value, belongs to the economic field. According- 
ly, every one recognizes it as being, anyhow, one of the ultimate 
productive factors. 

(e) Looking, now, at the remaining factors in our list, we 
note that all but two of them will naturally go together as 
being themselves products, though products which are wanted, 
not for their own sakes, but for the sake of something we 
expect to make out of them. Here we should have to put 
(b) (3), (c) (1), (e), (f), (g), and (h). With these should 
be reckoned (b) (2), — though this is not quite so plain, — since 
prepared land, looked at as prepared, is produced just as much 
as is pig iron or ingot copper. Let us for the moment name 
this group intermediate products. 

(f) Of the two elements remaining on our list, one is the 
last, time. What is to be done with it? At first thought, one 
might be disposed to say that time, however necessary to pro- 
duction, can not be an economic factor because it can not be 



*The simplest test of an economic factor is the presence or absence of 
value. 

30 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

bought and sold. But we must not be too hasty. In effect, time, 
or waiting power, is bought and sold, every day. The need for 
time in order to resort to more efficient methods naturally ex- 
presses itself in the need for surpluses of those goods which we 
are now producing, in order that we should be able to turn 
some portion of our efforts into the new channel. In short, 
we must have something ahead. Now, this getting something 
ahead can be done, so to speak, by proxy. Some persons whose 
incomes make it possible, save from those incomes and accumu- 
late stocks of money or money credit. These accumulations 
embody, we may say, waiting power, time. The responsible 
producer borrows them and then hires labor to initiate the 
round-about, time-consuming, methods. In thus borrowing, he 
is in effect buying time, waiting power; and the lender is selling 
such time or waiting power. Accordingly, in our present eco- 
nomic order, time, as an economic factor, manifests itself in the 
shape of loanable money funds. These the business world 
usually denominates capital; and we will for the moment accept 
this designation. 

(g) We have now but one of our items left, viz., (a), 
willing that production go on, assuming the responsibility of 
having things produced. At first thought, the setting up of this 
element . as a separate factor seems hardly less than absurd. 
Surely no one can produce without willing to produce, assum- 
ing the responsibility of producing. Does not every one who 
makes any contribution to the productive process in so far will 
the existence of the product? This sounds plausible; but it will 
not stand examination. The patent fact of experience is that 
the assuming of responsibility for the product's existence is a 
function which is separated from the several contributions 
necessary to the result. The men who supply land services, 
labor services, and capital services, respectively, leave to some- 
one who buys these services from them the bearing of respon- 
sibility for results. He wills those results; bears the anxieties; 
and suffers the losses. 

(h) The preceding analysis has left us provisionally five 
factors, land, labor, intermediate goods, money capital, and 
responsibility-taking. But some further revision and con- 
centration is necessary. The third of these five elements, inter- 

31 



PRINCIPLES OF ECONOMICS 

mediate goods, being themselves products, must be in some 
sense and degree mere embodiments of previous elements or 
factors. That is, it does not seem as if they could be said to 
constitute an original, independent, factor coordinate with land 
and labor. Ought we not, then, to drop this class out alto- 
gether, affirming with the socialist that such goods are merely 
"congealed labor" or, anyhow, that they are congealed land and 
labor? To this question, most economists more or less clearly 
give a negative answer. We must treat these intermediate 
goods as an independent factor, because they embody another 
element beside land services and labor services, viz., waiting, 
time. We do not adequately describe the matter when we say 
that the fisherman who, instead of catching fish directly with 
his hands, begins by making a net and then uses the net to 
catch fish, is merely working on a different plan from what he 
would in the other case. Such language suggests that the sac- 
rifices are absolutely equal in the two cases, that all the con- 
ditions requisite in the "net" method could be fulfilled by any 
one who could fulfil those requisite in the "hand" method, — 
assuming that he could make nets as well as use them. But, of 
course, such a statement would be quite untrue. The fisherman 
who has enough dried fish ahead so that he can devote, say, 
30 days to making a net, can resort to the "net" method. In 
contrast, the fisherman who has nothing to satisfy his hunger 
beyond today must be content with the "hand" method, even if 
he has just as much skill in net-making as his rival. That is, in 
order to be able to use roundabout methods, to begin by making 
intermediate goods and then use these to reach our true goal, it 
is necessary, not merely that one be able to labor in the ordi- 
nary sense, but also that he have the power to wait. If some 
one wishes to insist that this is only a special phase of labor, 
he surely has the right to use such lenguage, — though the 
notion seems rather ridiculous in view of the fact that this 
phase of labor is mostly performed by the very people who do 
little or no labor in the usual sense. But, whatever some per- 
sons choose to call it, this element is surely present in inter- 
mediate goods, and, to the ordinary mind, it is not covered by 
the word laLor. Accordingly, it is necessary to insist that the 
intermediate goods now under consideration are embodiments, 

32 



CHAPTER II. ANALYSIS OF PRODUCTION. 

congelations, of land services, labor services, and waiting. They, 
therefore, have to be distinguished as constituting in some sense 
and degree, a factor independent of land and labor. 

In the foregoing paragraph we have insisted that interme- 
diate products must be recognized as an independent factor. 
But the particular feature of these intermediate products which 
was used to defend our position, vis., that they embody waiting, 
was also provided for under the fourth provisional element, 
money capital, — surplus money funds devoted to the purchase of 
these very intermediate products. Now, it is obvious that we 
must not count this waiting element twice. Further, it is 
hardly less obvious that there would be little propriety in dis- 
tinguishing waiting power as embodied in money funds from such 
power when embodied in ordinary intermediate goods. In short, 
the seemingly reasonable procedure is to coalesce our third and 
fourth elements into one — capital ; and this is the universal 
practice where either is kept distinct from land or labor. 

We have now reduced our factors to four, land, labor, capital, 
and responsibility-taking. Ought we to take another step, com- 
bining the third and fourth into one, and, thus, reducing all to 
land, labor, and capital? Is not the assuming of the respon- 
sibility for production simply one aspect of the function of 
capital? or anyhow one function of capital coordinate wth the 
other function, waiting? Responsibility-taking obviously goes 
along With being the owner; and is that not true of waiting? 
Is not the lending capitalist virtually a part ozvner of the busi- 
ness and its outfit? This doubtless has much force. We 
should not be far astray in holding that the factors of produc- 
tion are three : land, labor, and capital. If we do this, how- 
ever, we must not forget that capital performs in the process 
two /unctions; waiting and responsibility -taking, and, in actual 
practice, these are to a considerable extent separated.* 



*It is worth the student's while to note that this and many other 
points in economic analysis which seem to outsiders needlessly subtle are 
after all only careful theoretic expressions of distinctions which have long 
been embodied in business practice. In that practice, the borrowing 
producer largely gets rid of the waiting part of the capitalistic burden 
by borrowing, while he retains, in large measure anyhow, the responsibility 
burden. He, not the lending capitalist, does the worrying, make the 
final decisions with respect to the conduct of the business, and suffers the 
loss if failure comes. 

33 



PRINCIPLES OF ECONOMICS 

3. Should the Factors of Production be Reduced to 
Two or One? 

The foregoing analysis of the productive- process has left 
us with four, or anyhow three, economic factors of production. 
Against this account of the matter, which may be described as 
the conventional or orthodox one, there has been, and still is, 
more or less opposition. Some would reduce the factors to 
land and labor; some, to capital and labor; some, to labor 
alone. The first of these opposing doctrines has already been 
more or less fully dealt with in the preceding division of this 
section. The principal ground on which is mantained the con- 
tention that land and labor cover the whole case, is that capital 
— intermediate got>ds — is produced by the combining of land 
and labor and, so, is not an independent factor, coordinate with 
those two. The inadequacy of this reasoning has already been 
explained : capital contains another element besides those which 
are, or can be, furnished by land or labor, using those terms in 
any natural or usual sense ; — to secure capital man must have at 
his disposal waiting power as well as labor. We can not, there- 
fore, rest satisfied with an analysis which reduces the factors of 
production to land and labor. Capital must be recognized as in 
some sense and degree an independent factor.* 

We have seen that some economists deny the right of cap- 
ital to be considered an independent factor in production. An- 
other group admit the claims of capital but deny those of land. 
Land, in their view, is only o particular kind of capital; and, so, 
the factors of production are labor and capital. Now, there are 
no doubt reasons for uniting land and capital (as heretofore 



*It will perhaps occur to the student that we ought to mean by 
capital, not the zvhole engine or net or car, but only some part, some 
feature, of it, — the waiting element in it as distinguished from the land 
and labor elements. This is surely in a way reasonable; and it is not 
improi3able that more than one of the somewhat startlingly novel ways 
of conceiving and defining capital which have appeared in recent years 
have their origin in a more or less conscious attempt to carry out this 
idea. Much stress is laid on the waiting idea, or on the time i-dea. The 
teacher of economics who is not prepared t© go -so far- as to ; adopt a 
totally new definition of capital, nevertheless often permits himself 
figurative forms of expression which bring out the same idea. Thus, he 
may perhaps describe capital as waiting power, bottled time, etc. But 
all such methods of treating the matter, if taken literally, meet one very 
serious difficulty: tlie peculiar element which characterizes capital as 
capital is separable from the others only by a very heroic abstraction which 
many find it difficult to use without giving it a concreteness to which it 
has no claim. 

34 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

used) under one designation. The two things have some ele- 
ments in common. But, for that matter, so do land, capital, and 
labor; and more than one recent writer has reduced all the 
factors of production to one, — capital. In fact, all analysis is 
more or less arbitrary. Everything which exists is in some kind 
and degree similar to, and connected with, everything else whch 
exists. Winding in and out, there are innumerable threads con- 
necting one concept with another ; so that, wherever we put the 
dividing line, we shall cut some real connections. Biologists 
have never agreed on any perfectly adequate method of dis- 
tinguishing animal and vegetable organisms. Within a fortnight 
(1911) I have been told by a professor of biology that he should 
not be surprised to hear almost any time that some one had 
proved the existence of consciousness in the particles of the 
huge boulder which constitutes the memorial of the class of '62. 
In general, then, all lines of demarcation must be illogical in the 
sense that they separate some things which have much in com- 
mon and put together some things which show radical differ- 
ences. The choice of the proper point of division is, therefore, a 
matter of expediency in view of all the facts of the case. Usage 
counts for a considerable ; significance in connection with great 
practical problems counts for much more. In the opinion of 
most economists, the behavior of land (in the economic sense) 
in respect to the determination of values, and so in respect to 
various practical problems in which value-determination is of 
prime importance, is sufificiently different from that of ordinary 
forms of capital, — ^intermediate products — to make the distin- 
guishing of the two in many cases highly desirable. Until that 
opinion is changed, economists will not consent to throw out 
land as an independent factor in production merely because a 
scholastic logic can find reasons for treating land and capital 
as one. 

As implied in the preceding paragraph, we shall here con- 
tinue the distinguishing of land from capital. A full discussion 
of the reasons for this decision would be out of place in 
Course 1. Further, the strongest reason, vis., that land and 
capital behave differently in respect to value-determination, can 
be appreciated only when we have considered the latter subject. 
There is, however, one objection to the orthodox position hav- 

35 



PRINCIPLES OF ECONOMICS 

ing considerable vogue in our day to which we will give a mo- 
ment's attention. As the student will remember, the orthodox 
analysis makes producibleness the line of demarcation : land is 
of natural origin, capital is a product. Now, to this distinction 
it is objected that real land, land as we know it, is producible 
just as truly as capital. It is, of course, true, they say, that the 
amount of land is unchanging, but the econo^nic supply is con- 
stantly altered by man. Now, it would be quite inconsistent for 
us to deny that our critics have a perfect right to use "produc- 
ible," "amount," and "economic supply" in these senses, if they 
think best. All analysis and definition is more or less inade- 
quate and illogical. But we can, I think, rightly object to their 
employing these meanings to prove that land is producible in 
our sense. As we use the terms, "economic supply"* 
is not broader than "amount," but narrower. If I 
can not first add to the amount of anything, I can not 
add to the supply of it; though I can add to the amount with- 
out adding to the supply. The natural explanation of the lan- 
guage cited would seem to be that the writer has made a false 
antithesis by joining the first member of one antithesis with the 
second member of another. In every producing combination, 
there is an unproducible something, the amount of which is 
properly contrasted with the economic supply of it. There is 
also a producible something the amount of which is properly 
contrasted with its economic supply. But we have no business 
to put the amount of the unproducible something into antithesis 
with the supply of the producible something. When I put on 
the market a field that is cleared of stones, drained, and lev- 
eled, I am adding to the economic supply of prepared land. Bui, 
unless I or some one else had already added to the amount of 
prepared land, I could not have added to the supply 
of it. In fact all this sort of thing seems to confuse 
the using of object A in order to produce object B with the 
producing of object A. The man who takes flour, out of this 
flour makes bread, and puts this bread on the market, is not 
only not adding to the amount of Hour, he is also not adding to 
the economic supply of Hour. He is adding to the amount of 
bread and he is adding to the supply of bread. 



'Save, perhaps, in the case of the fictitious supply of option trading. 

36 



CHAPTER II. ANALYSIS OF PRODUCTION. 

It may perhaps help the student at this point to be told that, 
by universal admission, the "land" of orthodox economics is 
seldom if ever physically separated from capital. Yet the sep- 
arateness of land is not a mere abstraction. Land more or less 
completely separates itself from the capital associated with it in 
the processes of price determination. Thus, under normal con- 
ditions, if the government levies a tax on buildings this causes 
the hire (rent in the popular sense) of such buildings to rise; 
while, if the government puts its tax on the site, this does not 
cause the hire of the site to rise, but does cause the price of the 
site to fall. It must be admitted that this economic separation 
of the producible and non-producible constituents is often im- 
perfect, — that some of the produced elements get inextricably 
tangled up with the non-producible — ; but this, it would seem, 
could invalidate our distinction only on condition that the par- 
ticular producible elements under consideration were able to 
draw the non-producible ones over into their class, in other 
words, to obliterate the distinction. But this surely does not 
happen. Instead, these particular producible elements have to 
give up all connection with their own kind, have to come under 
the dominion of the economic laws governing non-producible 
elements. 

We have now considered the objections to the conventional 
analysis of production which would reduce the factors either 
(1) to land and labor or (2) to capital and labor. There re- 
mains the objection which seems to reduce them to one, labor. 
It is probable that this way of looking at the matter is no 
longer of much significance. It seems, however, to have had 
more or less vogue among socialists and semi-socialists. This, 
of course, does not mean that any socialist would claim that 
labor can produce without nature's assistance, or can produce 
effectively without the assistance of capital. The latter factor, 
however, was quickly disposed of by insisting that it is only 
congealed labor. Land was got rid of in another way. It is, 
of course, necessary and it is not a form of labor. But it is a 
free good, i.e., a gift of nature. Under the present order, it 
has an economic character and, so, is an economic factor. But 
this economic character is given to it arbitrarily by permitting 
property in it; — men are permitted to own it, hence to give it 

37 



PRINCIPLES OF ECONOMICS 

value, and, so, to make it an economic factor. It is probable that 
few enlightened socialists of our day would support this con- 
tention. Its unsoundness is easily shown. Ownership is essen- 
tial to exchange value ; but mere ownership can not give such 
value. There must be scarcity as well. If there is monopolistic 
ownership, then the needed scarcity can be secured artificially; 
and, so, the economic character given to a thing may be arbi- 
trary in its nature. But the ownership of land is not usually 
monopolistic, — there are many competing owners. The value 
of land is, therefore, not arbitrary, but perfectly natural, in its 
origin. Under socialism, land would have value and, so, would 
be an economic factor just as truly as now; only, under social- 
ism, the owner of the -land would be the state rather than the 
individual. 

4. Relations of the several Factors of Production to one another. 
It is very plain that the most vital, central, element in the 
producing process is assuming the final responsibility for it, 
willing that production shall take place and exercising final 
authority in its conduct. It follows, therefore, that capital 
viewed as the factor on which responsibility-taking falls, is the 
primary, central, factor in production, as it is conducted in a 
highly developed industrial society. The entrepreneur, as he is 
now commonly called, the one' who is responsible for the ex- 
istence of the business, is the producer par excellence. All 
others engaged in the undertaking are naturally conceived as 
auxiliaries, as producers of services which the entrepreneur 
assembles, combines, into that commodity which is the product 
of the business taken as a whole. 

Illustrative Problems. 

1. "Here is a country with abounding natural resources and 
an energetic and industrious population; but its development is 
impeded by the lack of capital. Measures should be taken to 
draw in the surplus capital of England and other European 
countries." 

Explain more fully and with illustrations what the first 
sentence means. 

2. "The most of us live by our wits — spend our time wheed- 
ling the true producers, the men who work with their hands, 
into sharing with us the things which they produce." 

Give several illustrations of kinds of labor necessary to pro- 

38 



CHAPTER II. ANALYSIS OF PRODUCTION. 

duction which would not naturally be described as working with 
one's hands. 

3. How ought the fences on a farm to be classed, as land 
or capital? How about the tile drains? The trees in the wood 
lot? The trees in a young apple orchard? Does it prove that 
a given distinction is illegitimate or useless to show that you 
could not draw that distinction in every actual case? Illus- 
trate this point. 

4. Argue for the propriety of the statement that capitalistic 
production is round-about production. 

5. One eminent American economist is . disposed to define 
capital as "inchoate goods," i.e., goods in the process of becom- 
ing goods. 

(a) Mention some forms of capital to which that phrase is 
especially appropriate. 

(b) Try to make a plausible argument to show that the phrase 
applies fairly well even to a thing like a sewing machine. 

6. It has always been held that a pound of candy is capital 
while it is still in the hands of the merchant, although almost 
all writers say that it ceases to be capital when it passes into 
the hands of some consumer. Argue for the reasonableness of 
the first position. 

7. "Discovery and invention have doubtless played a very 
large part in securing our present high industrial efficiency. But 
they are not the whole thing. The increase of capital has been 
equally necessary ; for, without capital, invention could have 
accomplished little or nothing." Defend and illustrate the last 
sentence. 

8. "The common pursuit of forestry as a private business 
almost had to wait until capital became relatively very abun- 
dant." Why should this be true of forestry more than of wheat 
raising? 

9. The following is taken from a short story in a recent 
number of one of the popular magazines. The hero inherited 
great wealth in rolling mills and has for several years success- 
fully continued the business. He is also public-spirited and lib- 
eral. Referring to his charities, the author says : "What was it 
that he had given? Something that he... had never earned. 
His hands had never touched belt or pulley. He looked at 
them curiously. It zvas the toil-hardened hands of twelve hun- 
dred other men that made his giving possible — the hands of the 
men he was planning to turn off on Monda3^" 

Show that, if this was a normal case, we could impute to 

the services of the twelve hundfed workmen only a part of the 

net output of the mills; that the portion going to the proprietor 

. was reasonably enough credited to his contribution to the bus- 

39 



PRINCIPLES OF ECONOMICS 

iness. Enumerate several elements which probably entered into 
his contribution. 

10. Josiah Wright, the wagon maker, is making a stone boat 
which he expects to sell to some neighboring farmer. Now, a 
stoneboat is undoubtedly capital or capital goods ; yet in making 
that stoneboat, Wright is not, strictly speaking, producing cap- 
ital. Explain the riddle. 

11. Some writers have been disposed to affirm that, in the 
last analysis, all capital gets its start in a surplus of the means 
of subsistence, particularly food. This undoubtedly has con- 
siderable force as applied to primitive conditions. Illustrate the 
proposition for a community of fishermen. 

Section B. The Agents (Actors) in Production 

The preceding analysis of the productive process is an 
econoviic analysis, the factors brought out are economic factors, 
i.e., factors which are embodied in material objects or condi- 
tions controlled by human beings and having value. The con- 
trol of these several factors is, or at least may be, in the hands 
of different classes of persons. It follows, therefore, that there 
are different classes of producers, different agents or actors in 
production, corresponding to these factors. This matter has, 
of course, been already anticipated, but a more explicit analysis 
is demanded. 

1. The primary, central, factor in production is capital, 
viewed as the responsibility-taking element; and so, of course, 
the primary, central, agent in production is the person, natural 
or legal, who supplies this factor, who assumes the function of 
responsibility-taking. Adam Smith (1776) called him the un- 
dertaker. For obvious reasons this very desirable usage is out 
of vogue. In its place most English-speaking writers employ 
the French equivalent, entrepreneur. Recently some writers 
have taken to using a newly-coined term, enterpriser. 

Notes: (a) One who performs the function of responsibility- 
taking with respect to an old business is just as truly an entre- 
preneur as one who occupies the same relation to a new busi- 
ness. Every business, old or new, must have an entrepreneur. 
This forms a decisive objection to the statement sometimes 
made that profit — the remuneration of the entrepreneur — is the 
reward or wages of enterprise, i.e., taking the risk and general 
responsibility of starting new undertakings. It is also something 
of an objection to the name "enterpriser", since this suggests, 
not the entrepreneur as such, but a particular class of entre- 

40 . 



CHAPTER II. ANALYSIS OF PRODUCTION. 

preneurs, viz., those who show enterprise — courage — in starting 
new undertakings. 

(b) The student should be careful to distinguish the entre- 
preneur of a business from the promoter, the man who induces 
people to start it. 

(c) It is an error which in our day is very obvious to make 
the managing of a business the peculiar function of the entre- 
preneur, though not a few economists have made this mistake. 
The decisive consideration is that many entrepreneurs almost 
entirely hire their managing done, just as they hire stoking, 
engineering, book-keeping, etc., done ; and, so, managing takes 
its place as one of the many kinds of labor necessary to a busi- 
ness, and the men who do it are only a higher sor<" of laborers. 
It should be noted, however, that there almost necessarily re- 
mains to the entrepreneur a residuum of managing; — he must 
usually make final decisions with respect to certain fundamental 
policies, and he must at least choose one or more leading mem- 
bers of the managerial force. 

(d) It follows from the last sentence that they are some- 
what at fault who make risk-taking the sole function of the 
entrepreneur. Doubtless the taking of risk is one of the most 
conspicuous features of final-responsibility-taking; but it is not 
the only one. 

(e) In the case of industries undertaken by corporations, the 
corporation as such, that is, the collective unit, is, from the 
standpoint of formal logic, the true entrepreneur. But caution 
in interpretation is here necessary. The corporation acting 
through its usual organs, president, secretary, general manager, 
etc., can not be the entrepreneur ; since thegse organs are created 
by a more fundamental power, the board of directors. Again, 
the corporation acting through the board of directors, can not 
be the real entrepreneur ; since that body is created by a more 
fundamental power, the general meeting of stockholders. When 
at last we reach the general body of stockholders, acting in the 
way prescribed by their charter for the determination of funda- 
mental questions, we are in the presence of something, which 
from some standpoints, may fairly be called ultimate, — there is 
nothing behind to determine its action. This general body of 
stockholders, therefore, may put up a fairly good claim to the 
title of entrepreneur. In a sense, however, the function and 
title seem in some respects to fall on stockholders as a mere 
aggregate. This is particularly true at the starting of corporate 
undertakings. Whether or not the industry shall be carried on 
at all, i.e., the taking of the ultimate responsibility of produc- 
tion, rests with investors as individuals, not with a body of 
stockholders formally organized. Accordingly, for some pur- 
poses, we have to locate the entrepreneur of a corporation in 
the stockholders formally organized, while, for other purposes, 

41 



PRINCIPLES OF ECONOMICS 

we look on the mere aggregate of stockholders as occupying 
this position, 

2. Besides capital, serving as the responsibility-taking factor, 
we will remember that there are three other factors, land, labor, 
and capital considered as the factor which supplies waiting 
power. These three, as already indicated, may be conceived as 
subordinate to capital viewed as the responsibility-taking factor. 
For each of these, there is of course a corresponding agent or 
actor. The agent in the case of land is the land owner or 
landlord. He is the one who furnishes the use of the land or 
land services. 

As hinted in another place, it is possible to have an economic 
order in which private land owning is not permitted, and there- 
fore one in which the private /andlord would not be a producer, 
an agent in production. But it has not been possible since the 
very beginning of society to have an order in which some sort 
of landlord would not be an agent in production. For, just as 
soon as any part of this land came to be wanted by more than 
one person, it would come to have value, would become an 
economic good. Some one would inevitably appropriate it and 
take advantage of its superior desirableness. This might be 
the community as a whole or an individual. And, whether the 
one or the other, we should have to secure his participation in 
order to utilize the land in question as a factor in production. 
And what necessarily happened to early societies, shows what 
will always prove true : we can never get rid of the landlord 
as an agent in production. All zve can do will be to substitute 
public, for private, landlords. 

3. The third agent in production is the laborer, meaning any 
one who furnishes services which are the product of his own 
effort, whether these services are high or low, physical or 
intellectual. The $100,000 president of a corporation is a laborer 
just as truly, as his office boy. 

The mark which distinguishes the laborer from any other 
participant, if such there be, who furnishes effort services is the 
fact that services such as his can be hired. Mr. McGregor, the 
South University grocer, is an entrepreneur because he is re- 
sponsible for the business. Further, he jorobably does as much 
work as any of the clerks. But most of his efforts pertain to 

42 



CHAPTER II. ANALYSIS OF PRODUCTION. 

him, not as entrepreneur, but as laborer. They are just the 
sort of efforts that he can hire other men to put forth, and that 
many grocers do hire. It would, therefore, be quite illogical 
to put them under a dififerent head. Hence, they are labor, and 
with respect to them he is a laborer. 

As already brought out, there is probably a residuum of 
labor which must be performed by the entrepreneur as entre- 
preneur. But it is too slight in amount to merit serious consid- 
eration. 

4. The fourth agent in production is the capitalist proper. 
By this term we mean the one who lends capital to be used in a 
business, but does not assume the responsibility of the business. 
The return of his capital and payment for its use (interest) is 
assured him. The special function of the capitalist proper is to 
do the waiting involved in industrial processes, just as the spe- 
cial function of the entrepreneur is to assume the responsibility 
of production. The bondholders of a corporation are capital- 
ists; the stockholders are elements in the joint entrepreneur. 

The use of "capitalist" here defined is somewhat technical. 
Economists often employ the term as the public do, i.e.j to include 
entrepreneurs as well as capitalists proper. From some stand- 
points, we even look on the landlord as a capitalist. Rut the 
use explained above is frequent and at times convenient. 

Note : It is scarcely necessary to say that, in the real world, 
there is never probably any such complete separation of func- 
tions as might be suggested by the above analysis. The same 
man often fil's two or more roles. The typical farmer is land- 
lord, capitalist, laborer, and entrepreneur, all in one. The 
grocer, in the above illustration, is anyhow entrepreneur, capi- 
talist, and laborer. The distinctions made are primarily func- 
tional; fhough they may be, to a considerable extent, personal 
as well. 

Illustrative Problems. 

1. "In cooperative production (meaning production in which 
the workmen own the business) the place of the entrepreneur 
is taken by a manager elected by the workmen." — Text-book. 
Criticize. How is the entrepreneur constituted in cooperative 
production ? 

2. "Today, all over the land, masons, hod carriers, carpenters, 
and so on, are building palaces which other people are to live in. 
When socialism triumphs, all this will be changed. The worker, 
no longer robbed of the fruits of his labor, will himself occupy 

43 



PRINCIPLES OF ECONOMICS 

the palaces he builds, wear the broadcloth he makes, and eat the 
choice viands he produces." 

(a) Does justice require that the worker should have the 
right to consume the particular object he expends effort on? 
Explain. 

(b) If it did, would the particular set of workers, — masons, 
hod carriers, carpenters, and so on, — who construct the palace, 
have the exclusive right to enjoy it? Explain. 

(c) Show that other persons besides "workers" in the sense 
here used have supplied conditions necessary to the existence of 
the palace. 

3. Until recently it was usual to teach that the peculiar 
function of the entrepreneur is to manage, direct, industry. One 
feature of modern industrial organization almost compels us to 
reject this idea. Explain. 

4. "Postponing consumption so that production may be car- 
ried on in a roundabout way is the function of the capitalist." 
— Text-book. Explain and illustrate. 

5. Why do we say that every stockholder of a corporation is 
an element in the corporate entrepreneur while a bondholder, 
who also has capital in the concern, is not? 

6. Not many years ago Mr, W, after some months of pains- 
taking negotiation, induced a number of persons owning cer- 
tain lands on the Copper Range to join with him in organizing 
a corporation to build a railroad, open mines, etc., — Mr. W 
putting in some land of his own. For his fee, Mr. W was to 
receive a certain number of shares in the stock of the com- 
pany. 

Distinguish with explanations the two economic roles played 
by Mr. W in this matter. 

Section C. The Costs of Production. 

A very important phase of the productive process is cost, 
by which we mean, in general, some sacrifice which has to be 
made if production is to take place. 

1. Utility Costs and Disutility Costs. 
Costs naturally fall into two classes, (a) utility and (b) dis- 
utility costs. By utility cost we mean a sacrifice which consists 
in relinquishing one utility to gain another. I have intended to 
use certain boards to make a cold frame for roses. I decide to 
use them making a walk. I have intended to use a certain sum 
of money to put a new porch on my house. 'Instead, I use it 
to take a trip to Muskoka Lakes. Here, the cold frame is one 
of the costs of the sidewalk; the porch, the cost of the trip to 
Muskoka. 

44 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

A disutility cost means a sacrifice which consists of some 
action, some procedure, which in itself involves discomfort; 
e.g., labor when one is weary. Disutility is the opposite of 
utility. A thing possesses utility if it is fitted to give us satis- 
faction ; disutility if it is fitted to bring us dissatisfaction, discom- 
fort. 

The sam.e cost may be either a disutility cost or a utility cost, 
according to the att'tude or purpose of the person incurring that 
cost. Thus, the effort which I expend doing an errand down 
town is a disutility cost because of its irksomeness ; but it may 
instead be viewed as a utility cost because I might have ex- 
pended it enlarging my rose bed. In like manner, something 
naturally viewed as a utility cost may really be a disutility cost 
in disguise. Thus, if I give up the cold frame entirely in order 
to build the sidewalk, the cost of the sidewalk is a utility cost. 
But, if all the time I intend to replace the lumber from later 
earnings obtained by doing work which I would not otherwise 
have done, and actually carry out this intention, then the true 
cost of the sidewalk is a disutility one, the effort from which this 
portion of my later earnings comes. 

Opportunity cost is a phrase sometimes used to cover a par- 
ticular kind of utility cost. If a workman's reason for wanting 
a wage of 20 cents an hour from me is the fact that he can earn 
this sum from some one else, this sum expresses the opportunity 
cost to him of supplying me with his service. When a land owner 
can rent a certain piece of ground for pasture at $130 a year 
and I want it for a golf ground, then $130 is the opportunity 
cost of supplying my want. 

It is very important to note that utility and disutility cost, 
being true opposites, are entirely commensurable. That is, I can 
properly say that a certain utility is of the same significance to 
me as a certain disutility. In fact, all admit that we make 
such measurements constantly in that we decide that, after un- 
dergoing some particular disutility cost up to a certain point, 
the reward no longer pays for the sacrifice. 

There is at present considerable controversy as to whether 

disutility costs really play any considerable part in the existing 

economic order, especially in determining value. One important 

group of recent writers, the so-called Austrian school, take the 

45 



PRINCIPLES OF ECONOMICS 

negative position ; and they have •. considerably influenced the 
opinion of others. According to these writers, the fact that 
persons to whom a laborer's services are worth much more 
than 20 cents per hour have to pay only that amount is due to 
the other fact that such labor has a utility or opportunity cost 
of only 20 cents. At the opposite extreme stand some who 
hold that the price of such labor reaches 20 cents because, and 
only because, this expresses the disutility of supplying said labor. 
In the present course, it is taught that both utility and disutility 
costs have a share in determining value. 

2. Kinds of Disutility Cost. 

(a) Disutility Cost of Labor. It is obvious to every one 
that labor involves one or more disutilities, and that these con- 
stitute a cost of production in some sense, if not a true eco- 
nomic cost, i.e., one which becomes efifective in the economic 
realm. The most conspicuous of these disutilities are (1) the 
irksomeness of the labor itelf when continued beyond a certain 
point, and (2) the loss of leisure which might give opportunity 
for positive enjoyment. - 

(b) Disutility Cost of Supplying Capital. Again little argu- 
ment is needed to show that, speaking generally, the supplying 
of capital involves a disutility, and, so, is in some sense a cost. 
The man who furnishes capital doubtless gets back a full equiv- 
alent ; but, then, he gets it back at a later period. In short, he 
must incur the sacrifice or disutility of waiting. Now, it is no 
doubt true that this waiting is not a cost in just the same sense 
as is labor. Further, it is not unlikely that, in a complete theoreti- 
cal analysis of the matterfi some more precise designation than 
the word cost could be found for this particular sacrifice of 
waiting. It is even probable that they are right who say that 
the sacrifice made by the man who devotes his capacities to pro- 
ducing something which takes time as well as labor (something for 
which he must wait as well as work) really consists, not in an 
addition to the cost, but rather in a deduction from the return. 
But, however this may be, there is no doubt that we have here 
a sacrifice which must he undergone if time-consuming methods 
of production are used which sacrifice is additional to the sacri- 
fice that is incurred if only methods not requiring time are 

used. That sacrifice, therefore, is an additional cost in the 

46 



CHAPTER IL ANALYSIS OF PRODUCTION. 

sense in which the term was defined above as some sacrifice 
zvhich has to he made if production is to take place. The prod- 
uct requiring time-consuming methods must have a significance 
to the producer greater than that of the non-time-consuming 
one. The latter must have a capacity to give him satisfactions 
sufficient to offset the sacrifice of labor which it involves, but 
need not have more. The time-consuming product must have 
a capacity to give satisfactions sufficient to offset the sacrifice 
of the labor involved and also that of the waiting involved. 
On this point there is practically no disagreement. This being 
true, the controversy becomes chiefly one of words. As the 
term cost is naturally understood by an ordinarily intelligent 
person, waiting is a cost of production. To find any other term 
which will better describe its relation to the case would be ex- 
tremely difficult, if not quite impossible. 

Another objection to the doctrine that waiting or abstinence 
is a cost of production which is often urged, is that most men 
who accumulate much capital have such large incomes that 
they could not spend those incomes if they tried to. To them, 
therefore, saving involves no true abstinence, or anyhow no dep- 
rivation. The answer is this : to say that providing any par- 
ticular factor of production involves, in general, a disutility cost, 
is not to say that this is true in every single case. All admit 
that labor involves such a cost; but some labor is positively 
pleasurable. So, it is possible that some men are in such a 
situation that spending their incomes would involve more dis- 
utility that saving them. These facts, however, do not justify 
us in denying that labor and capital, taken by large, involve a 
disutility cost. To be more specific, all such questions turn on 
what is called the marginal portion of the supply, that is, the 
portion last supplied, or the portion which would be withheld if 
any were. This part of the output of anything is the significant 
one, — the one we have to take special trouble to secure. The 
men who supply it hold the key to the situation. They must be 
satisfied ; and to them labor and capital have disutility costs. 
We therefore say that this is true of labor and capital, gener- 
ally speaking. 

(c) Disutility Cost of Undertaking the Entrepreneur Func- 
tion. We have seen that the distinctive function of the entre- 

47 



PRINCIPLES OF ECONOMICS 

preneur is to assume the responsibility of production. We also 
noted that this is in large measure a function which must be 
undertaken by capital or at least by property ; — the entrepreneur 
can not normally induce the outside capitalist to supply capital 
as waiting power unless he (the entrepreneur) has property 
which can be pledged to insure the capitalist proper against loss. 
Now, in thus staking his property on the success of the produc- 
tive process, the entrepreneur surely suffers disutilities. Not to 
dwell on the psychological element of anxiety and general 
sense of burden, he manifestly assumes the risk of losing his 
pledged property in whole or in part. For, of course, there is 
always present the danger that there will take place unexpected 
changes in conditions of such a character as to cause him to 
lose more or less of his property, anyhow of the value of that 
property. Insofar as such losses in value occur with consider- 
able regularity in the hfe of a business so that they can be 
averaged and covered by an addition to selling price, they do 
not constitute a new kind of cost, but merely an addition to 
the amount of those kinds already discussed. The persons 
engaged in the productive process must simply undergo more 
of the same old sacrifices, labor and waiting. But there are 
many value-destroying changes which, in the business lifetime 
of the individual entrepreneur, show no such regularity, sub- 
mit to no average, and so can not be covered by an addition to 
price. To the individual entrepreneur such losses are final, 
never-to-be-recouped, losses. Assuming the risk of suffering 
such losses involves to most persons a disutility different from, 
additional to, any yet considered. Doubtless some people of 
gambling temperament enjoy assuming such risks, and so would 
rather take them than not. But, in my opinion, this does not 
represent the ordinary entrepreneur attitude of mind, anyhow 
not that of the marginal entrepreneur, — i.e., the one who is 
least disposed to stay in the business, who would be the first to 
quit were conditions made more onerous. If this is the correct 
opinion, then responsibility-taking must be viewed as one of 
the disutility costs of production — one of the sacrifices which 
have to be made if production is to go on. 

(d) Disutility Cost of Land. Land, as understood by most 
economists, is the indestructible substratum of nature's share in 

production, position on the earth's surface. It, therefore, can not 

48 



CHAPTER II. ANALYSIS OF PRODUCTION. 

be produced and, so has no primary, original, disutility cost. 
But, when land is wanted and the quantity of it is scarce rela- 
tively to wants, it of course will come to have value like any 
other thing which is wanted and scarce; and when land thus 
comes to have value, the owning of it comes to involve the 
burdens (as well as advantages) which belong to all owning of 
wealth. That is (1) the owner must forego the enjoyment of 
some immediate, present, form of wealth which he could get 
with the money tied up in the land (to use the business man's 
language) ; and (2) he must run the risk of having the value 
of the land decline. In short, owning the land involves the two 
disutilities which, as already shown, attach to capital, vi^., wait- 
ing and risk-taking; though, in the case of land, these disutili- 
ties present themselves as derivative, not original, disutilities. 
But, while supplying the land factor in production comes to in- 
volve disutility costs, these are not new ones but those already 
brought out as attaching to capital. Hence, summarizing this 
whole account of disutility costs, we may say the chief costs 
of this sort are three: (1) labor, (2) waiting, and (3) risk- 
taking. 

3. Utility Costs. 

We have already seen that a thing has a utility cost pro- 
vided the production of that thing involves sacrificing some 
other thing which would have supplied one or more utilities. 
It is evident that supplying any one of the three factors, land, 
labor, and capital, may involve such a utility cost; for any one 
of them may be put to different uses, and any one of these 
uses may be conceived as a cost in producing one of the others. 

4. Money Costs. 

The disutility and utility costs just considered are to be con- 
ceived as sacrifices made by the persons acutally participating 
in production. They are often spoken of as the real costs 
of production or simply costs. In contrast we have the money 
costs (often called expenses), the outlay in money which en- 
trepreneurs have to make in order to get the various elements 
which they need in their productive operations. This statement, 
however, must be interpreted so as to make money costs include 
any sum which the entrepreneur allows himself for factors or 

services which he might have bought but which, in fact, he 

49 



PRINCIPLES OF ECONOMICS 

himself supplies. Thus, if the entrepreneur himself works as 
manager or bookkeeper or clerk, he allows himself wages, and 
we should count these as part of the money cost. So, if he has 
capital invested in the business — surely he almost always has, — 
he allows himself interest on this capital, and that interest we 
include in the money costs. True profits, the return going to 
the entrepreneur as such, i.e., to the entrepreneur ignoring his 
contributions as a laborer or a capitalist, — these are the reward 
of a service which could not from its very nature be bought 
on the market; this element would not, therefore, be counted 
as part of money costs. However, it will be included in entre- 
preneur's costs, which will be explained in a moment; and, in 
this course, it will usually be included when the word cost is 
used without any qualifying term. 

It would probably be granted by every one that money costs 
in some sense and degree represent the real costs of production, 
though opinions would differ as to the exactness of such repre- 
sentation. Those who believe that utility, opportunity, costs 
play the decisive part in fixing rent, wages, and interest, natur- 
ally look on money costs as quite closely corresponding to utility 
costs. Those who believe that disutility costs have much to do 
in determining wages and interest, look on money costs as a 
fairly precise expression of disutility costs. Money costs are, 
in any case, of much greater significance in economic science 
than real costs of either sort, since they are the only available 
expression of such costs! Granting that a knowledge of the 
sacrifice made by laborers or capitalists is important to us, it 
is plain that we can get such knowledge only by assuming that 
the extent of the sacrifice is expressed in the money prices • 
which we have to pay to get men to undergo such sacrifice. 

In enumerating the money costs, it would perhaps seem nat- 
ural to group them just as we group the real costs which they 
more or less fully express ; and this could be done in a rough 
way. That is, we could reduce substantially all money costs 
to the money value of labor, of waiting, and of risk-taking, or 
in other words to wages, interest, and profits. But a good deal 
of the labor, waiting, and risk-taking which enter into the cost 
of a particular commodit}'^, come over from the past in the shape 
of goods which were earlier produced and are now being used 
in the current process. The price which the entrepreneur has 

50 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

had to pay for these goods has often departed more or less 
from that price which expressed their real cost, and so we can 
not use the latter as an equivalent of their cost in the current 
productive process. It is therefore best, in reckoning money 
cost, to set down the actual market value of past products used, 
without attempting to analyze them into their ultimate money 
costs — wages, interest, and profits. We have, then, as the appar- 
ent money costs of production the following: 

(1) Rent of the site. 

(2) Hire (rent in popular usage) of buildings or other dur- 
able capital goods. 

(3) Money value of capital goods consumed, such as raw 
materials, tools, machines, etc. 

(4) Wages of current labor, — covering labor of all kinds, 
including both wages in the ordinary sense and salaries. 

(5) Interest on all the money capital currently invested in 
the business where such interest is not already covered under 
preceding heads. 

Comments: (a) The case of rent as a money cost presents 
considerable difficulties. The more othodox doctrine makes it 
sometimes a cost, sometimes not. As already brought out, in- 
sofar as it represents disutility costs at all, these are not orig- 
inal but derivative. Being such, they are important in some 
cases, e.g., questions of justice in distribution; unimportant in 
others, e.g., in questions of value or price determination. But 
rent sometimes represents a utility or opportunity cost. In that 
case, it is important in problems of value or price but not in 
problems of distributive justice. But these nicer matters of 
theory will necessarily come up again in other connections. 
Generally speaking, all are agreed that rent is a money cost to 
this extent that the individual entrepreneur is usually con- 
strained to treat it as one of the outlays which are prerequisites 
of the productive process. 

(b) Costs (3), (3), and (4) need no comment. Number 
(5) is not quite so simple. It includes, first, interest paid out 
by the entrepreneur to others from whom any part of his capi- 
is borrowed, and, secondly, interest credited to himself on any 
capital which he has himself put into the business. The first 
is a plain case. The second perhaps deserves a word. Suppose 
the entrepreneur buys with his own money, say, $40,000 worth 
of lumber to be worked up into furniture. Evidently the re- 
sulting furniture costs this $40,000 anyhow — this item being 
covered under cost No. (3) ; — but, in addition, it costs interest 
on the $40,000 for the period ordinarily required from the time 
the lumber is bought till the furniture is sold and paid for. 

51 



PRINCIPLES OF ECONOMICS 

Supposing this period to be one year, then with interest at 5>2 
per cent, we have here a cost of $2,200, which must be charged 
to the furniture and credited to the entrepreneur. In a similar 
way, if he uses $20,000 worth of machinery, the cost of keeping 
it up, — repairs and replacement — will be provided for under 
cost No. (3) ; but interest on $20,000, i.e., $1,100, must also be 
earned, and this must be charged to the furniture and credited 
to the entrepreneur. Similarly, if he finds it necessary for the 
efficient running of this business to keep a balance with his 
bank of, say, $800, interest on this, $44, must be charged to the 
furniture and credited to the entrepreneur.* 

5. The Entrepreneur's Cost. 

The particular kind of cost having greatest practical signifi- 
cance in economic discussions is cost to the entrepreneur, the 
responsible producer; for his sacrifice plays a large part in 
determining the prices of goods. Cost to him might very natur- 
ally be looked on as breaking into two parts: (a) Money out- 
lay, (b) All sacrifices undergone by himself, e.g., in supplying 
the capital which he himself furnishes, in performing different 
kinds of labor, in taking the responsibility of having production 
go on. Tn practice, however, the entrepreneur usually divides 
cost in the way already hinted at. That is, such parts of his 
own contribution as could be bought on the market and. so, 
have known prices, he reckons in terms of money, just as if 
he had purchased them from other people. This leaves only 
one cost unprovided for, i.e., the sacrifice or disutility of assum- 
ing the responsibility of production which necessarily forms a 
class by itself. According to this analysis, Entrepreneur's Costs 
classify as follows : 

(1) Actual outlay of the Entrepreneur. 

(a) Money Costs. 

(2) Expression in money of the Entrepreneur's contributions, 
in so far as they are purchasable. 

(b) Real cost or sacrifice of assuming ultimate responsibil- 
ity, — this having its objective expression in money profits. 

It is Entrepreneur's Cost which we shall usually have in 
mind when employing the term cost without a qualifying term. 
That is, we shall commonly mean by cost money cost, as already 



*Remember that we are here talking about capital which he himself puts 
in. If any of these items are covered from borrowed capital, their interest 
is provided for in the first part of this paragraph. 

. 52 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

defined, plus such amount of profits as is necessary to insure 
the entrepreneur's continuance in the business. 

Illustrative Problems. 

1. Suppose that a Crusoe has some article, say an umbrella, 
which he considers quite indispensable, and that he is reflecting 
on what it would cost him to replace it, if it were destroyed. 

(a) Make a hypothesis under which that cost would present 
itself as a utility cost. 

(b) Make a different hypothesis changing the cost to a dis- 
utility one. 

2. Suppose that Crusoe looked on his umbrella as having 
a utility to him which he estimated at $10. Suppose, further, 
that he could make another just as good with five days' labor 
and that he estimated the disutility of a day's labor at $1. 

(a) What is meant by the last clause? 

(b) Is it reasonable to estimate the disutility of a day's 
labor in such a way? 

(c) What value would Crusoe probably set on the umbrella? 
why? 

(d) What would determine that value — utility or cost? 

3. Here is a site which yields each year a net income of 
$1,000. and which will presumably keep on doing this indefinite- 
ly. Seemingly such a site ought to be worth $1,000 multiplied 
by infinity, or, as human beings can not be expected to reckon 
so far ahead, let us say by 100; fbit is, it ought to be worth 
$100,000. As a matter of fact, the site would not be worth 
more than $20,000. How do you explain the discrepancy? 

4. We often hear people complain of what they consider 
the unreasonable profits of druggists or other merchants, say- 
ing that these dealers clear from fifty to one hundred per cent 
on a large part of their sales, while they have no right to more 
than eight or ten per cent. Does the fact that fifty or a hun- 
dred per cent are cleared on individual sales prove that a mer- 
chant gets more than eight or ten per cent real profit? 

5. Suppose that democratic socialism has replaced the pres- 
ent order so that the state, governed as a democracy, is the sole 
landlord, capitalist, and entrepreneur, hiring its citizens to labor 
at the various kinds of word needed, paying them wages, and 
selling them the various kinds of goods produced. 

(a) Show that it would be desirable from time to time to 
increase the amount of capital at the disposal of the state. 

(b) Show that this increasing of the capital would require 
abstinence on the part of the citizens. (Under a democratic 
socialism, effort would doubtless be made to distribute this bur- 
den equally for the time being.) 

(c) Show that, in the long run, equity, as commonly under- 

53 



PRINCIPLES OF ECONOMICS 

stood, would require that the state should charge a higher price 
for a product costing a certain amount of labor plus five years 
of waiting, than for another product costing an equal amount 
of labor and only one year of waiting. 

(d) What money cost in our system would this difference 
in price represent? 

6. The stockholders of a bank put into the business only 
$100,000; yet the bank takes in five or six per cent interest on 
loans which amount to, perhaps, $900,000. Must we not say 
that such a bank is making outrageously large profits? No. 
Explain. 

Section D. What is it to Produce? 

Up to this point we have assumed that the general nature 
of production is so well understood that no discussion or ex- 
planation of this point is needed. This procedure was perhaps 
justified in that (1) up to this point we have had little if any 
need for a clearly defined conception of production, and (2) 
such a conception could not be worked out at all easily before 
the analysis which we have given had been mastered. Now, 
however, we must go into this matter somewhat fully. 

1. The Word Production will be used in Different Senses. 

It is no doubt theoretically desirable to employ every scien- 
tific term in just one sense. But, in fact, such precision is rare- 
ly possible and under actual conditions seldom expedient. Such 
a course would require us to neglect important points of view 
or spend much of our time coining new terms. Production is 
a word which most of us, probably, use in several different 
senses, some broader, some narrower. This will doubtless con- 
tinue to be the case ; and little harm need result, if we are 
careful to preserve consistency in the matter. The gravest 
danger is that we shall affirm or deny that some one produces 
in one particular sense, and then in a moment deduce prac- 
tical consequences from our affirmation as if it had been made 
in a quite different sens^. Thus, there is a proper enough 
meaning of the word producer which permits its application to 
the market-gardener but not to the grocer. But, if we say 
"the grocer is not a producer (in this sense) therefore he is 
a parasite" we are confusing two quite different meanings. In 
the sense that a producer is one who extracts or grows or 
makes some particular thing, the grocer is not a producer. In 
the sense that a producer is one who does something which 

54 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

contributes to the satisfying of our wants, the grocer is a pro- 
ducer; and so, of course, he is not a parasite, since a parasite 
is a person who takes without giving anything in return. 
2. Broad Meaning of Produce, 

The meaning of produce which will be most used in this 
course and which probably has most vogue among present-day 
economists, may be brought out by the following statement: To 
make any contribution to the satisfying of human wants, 
whether this is done by persons or things, provided said con- 
tribution has a price or value, is to produce. The idea of this 
definition is to recognize as productive anything which is re- 
sponsible, in any sense or degree, for the existence of the prod- 
uct, provided it has an economic character. That such a way 
of conceiving production is reasonable ought not to be difficult 
to show. That, in general, we naturally go as far as possible 
in admitting whatever is responsible for the product, seems al- 
most self-evident. Surely the fundamental reason for calling 
any act or thing productive is the fact that the existence of the 
product is conditioned upon it; and it would not appear on the 
face of things reasonable to shut out the supplying of one con- 
dition while admitting another, — to call the raising of straw- 
berries productive, the carrying of them to market unproduc- 
tive, or to call the making of a lawn mower productive, using 
it to mow a lawn unproductive. Our real difficulty, then, is to 
justify our definition in respect, not to its breadth, but rather 
to its narrowness. Can we reasonably put in the qualification: 
"provided said contribution has a price?" 

In the light of previous discussions, an affirmative answer 
is inevitable. We are studying economics, not physical science. 
The sort of production we are concerned with is economic, not 
physical, production. But economics, as such, takes account only 
of those things which are economic, — i.e., which have to be 
treated economically, have value or price. Our definition of 
production, therefore, has to be restricted to acts or conditions 
which have a price. 

Comments: (a) The emphasis laid on price in the above 
definition must not lead the student to imagine that said defini- 
tion would be quite unsuited for an economic order radically 
different from the present one, e.g., communism. In such an 
order, value would still be used to express the relative import- 

55 



PRINCIPLES OF ECONOMICS 

ance of things; and the communal bookkeeping would credit 
something of the product to such factors as possessed an eco- 
nomic character — had value — but not to the others. 

(b) The emphasis laid on price or value must not lead us 
to imagine that to produce is to be responsible for the existence 
of value. It is, of course, the production of wealth that we are 
talking about ; and, since wealth has value, it might seem that 
to produce one must create value. But this is a mistake. The 
producer as such is not responsible for every element in wealth, 
but only for its fitness to satisfy wants, — its utility. His task 
is to do whatever needs to be done in order to give wealth this 
fitness — this utility. Many obstacles stand in the way of having 
things just right to satisfy wants. Many conditions must be 
fulfilled before the result is reached. To overcome any of these 
obstacles, to fulfill any of these conditions, is to produce. Now, 
these conditions must be fulfilled before people will want things 
and, so, before things will have value. The producer, therefore, 
is contributing toward the existence of value. But something 
more is necessary which the producer does not supply, viz., a 
dem.and on the part of others. Still another thing is necessary 
which he is really neutralizing, viz., scarcity. Accordingly, it is 
not proper to describe production as "the creating of value." 
We can conceive acts which would tend to increase value which 
are the very opposite of productive, e.g., destroying a portion 
of a tobacco or coffee crop. 

(c) We have laid so much stress on utility, as the element 
which the producer is responsible for that some further ex- 
planation of the term seems needful. In general the economist 
means by utility capacity to satisfy wants. More particularly, 
he applies the term to any such capacity, whatever be the par- 
ticular want involved. Thus, the capacity to give one aesthetic 
enjoyment or even vicious enjoyment is utility. To the econ- 
omist, diamonds and whisky are just as truly useful as coal 
or bread.* 

Still further defining the economist's use of this term, it 
should be said that utility includes not merely those conditions 
which inhere, so to speak, in the object itself, but also those 
conditions which consist in the relations of said object to men. 
Thus a loaf of b'*ead situated in a place where it is wanted is 
"more useful than jn exactly similar one situated where it is not 
wanted. 

Accordingly, the economist recognizes several kinds of utility 
which at first have a strange sound. Thus, he talks of place 



*This of course does not mean that the economist holds different ideas 
from other people as to the relative importance of necessaries and luxuries 
or as to the undesirableness of whiskey-drinking. But, from our standpoint, 
it is necessary to recognize the common element in diamonds, whiskey, 
and bread, i.e., the capacity to satisfy human wants; and utility seems to 
be the only suitable word for the purpose. 

56 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

utility, illustrated when the bread is carried from the place 
where it is not wanted to the place where it is wanted; time 
utility, illustrated when ice is kept from the cold months when 
it is not wanted till the warm ones when it is wanted ; and 
ownership utility, illustrated when a commodity passes from 
the hands of one who has no need for it to those of one who 
has such need. More obvious forms of utility are elementary 
or substance utility, illustrated where copper is gotten out of 
the mines of the Lake Superior region ready to be used in the 
making of wire ; and form utility, illustrated when that copper 
is made into wire ready to be used in carrying an electric cur- 
rent. 

(d) It is hardly necessary to say that those who favor the 
broad definition of production which we are now considering, 
include among producers not only those who supply commod- 
ities, i.e., material objects having value, but also those who sup- 
ply personal services, i.e., desirable changes in the conditions 
of objects or persons effected by other persons and having 
value.* See Reading IV. 

(e) It is hardly necessary to say that acts which are pro- 
ductive under one set of conditions may not be productive 
under another set of conditions, in that they contribute to the 
satisfaction of wants under the first set but not under the sec- 
ond. In particular, some acts which are useful under the pres- 
ent economic order might not be under socialism. Persons 
performing such acts would therefore be producers in the first 
case but not in the second. 

(f) It does not follow from our account of the nature of 
production that every one whom it accounts a producer really 
deserves the share which he gets for his contribution. Thus, 
it may be that the legal arrangements under which he is per- 
mitted to control a certain factor of production, say land, and 
so to make a certain contribution to production, are quite wrong. 
But, so long as those arrangements prevail, the contribution 
has to be imputed to him, and so he is a producer. The con- 
troversy, however, really belongs to a later division of the sub- 
ject, i.e., Distribution. 

(g) If we wish to express ourselves with precision, we 
should attribute to each producer the particular commodity or 
service for which he is immediately responsible. Thus, the 
farmer produces, not bread or flour, but wheat. The miller pro- 
duces not bread, but flour. The employees of the miller pro- 
duce not flour, but services, which the miller combines with 

*Commodities and services are contrasted most sharplv in that the 
former can be delivered to the person who buys them after they have 
been made, — independently of the producing process; while services can 
be delivered to, appropriated by, the person who is buying them, only 
while they are being produced. Services are usually changes in the condi- 
tion of the propertv or person of the one who buys them. In consequence, 
they must usually be produced in connection with such property or person. 

57 



PRINCIPLES OF ECONOMICS 

the services of various machines and wheat in such a way that 
he produces flour. 

Illustrative Problems. 

1. Is it fair to say that the conception of produce held by 
a man who calls all non-producers parasites is the same as 
the one we have been considering? 

2. "St. Thomas is not a producing island. Its importance 
consists in its position as a harbor of refuge and a coaling sta- 
tion, and as a place for refitting vessels." Show from the pas- 
sage that St. Thomas is a producing island, as we understand 
the word. 

3. Have the playing cards of a gambler utility? Are they 
wealth? Has a diamond ring utility? 

4. A man who is getting no income now but expects to 
have one six months from now borrows $100 from his neighor, 
promising to pay back the $100 and $6 more at the end of a 
year. 

(a) Does the $6 represent any advantage, — service, — re- 
ceived by the borrower? 

(b) If so, can the lender reasonably be credited with the 
production of that service? 

5. "Only miners, lumbermen, farmers, and such like ought 
to be called producers ; for they are the only ones who add 
something to the total wealth. The rest merely change the 
form or relations of the things which the above-named pro- 
duce." 

Show that there is no essential difiference in the contribu- 
tions of the farmer, the miller, the baker, the grocer, and the 
delivery man. 

6. "The Chinaman lives economically. He earns all he 
possibly can and saves it and takes it back to his native land. 
He is a very economical consumer, and instead of being a 
wealth prodiicer, acts as a leech upon the wealth of the nation, 
sucking in all that he can and taking it away to enrich the land 
of his ancestors." Criticise the part in italics. 

7. "Only the people who work with their hands are true 
producers. All the rest live off them." 

Argue that brainworkers, managers, architects, inventors, et 
al. are also producers. 

8. "A service is not a material thing but a satisfaction pro- 
duced in us by means of the goods or efforts of other persons." 
Criticize. 

9. Mr. X. hires the opera house for an evening and hires 
the Mendelssohn Quartette to give a concert in it. I pay 75 
cents to hear the concert. 

(a) In precisely what does the wealth which I buy consist, 

58 



CHAPTER II. ANALYSIS OF PRODUCTION. 

the work of the singers, the pleasure I derive from the singing, 
or something else? 

(b) Did the Quartette produce the wealth I bought, or 
something else? 

(c) If the Quartette did not, who did? 

10. "Thus there are today tens of thousand of lawyers, bank- 
ers, traders, middlemen, speculators, and others, whose functions, 
necessary to the capitalistic regime, would (under socialism) 
cease to have any value. They would be compelled because of 
this to enter the producing class." 

(a) Show from the quotation itself that, under a reason- 
able interpretation of the phrase " producing class," the groups 
of persons named are already in that class. 

(b) May the labors of these persons be productive now, 
although they would not be productive under socialism. Don't 
ft)rget to explain. 

11. "Labor alone is the producer of wealth ; take away 
labor and not all the capital in the world could produce any- 
thing." 

Allowing the second clause to be true as a statement of fact, 
does it prove the proposition contained in the first? 

12. Accepting the conception of wealth given in these Out- 
lines, the conductor of a street car is a producer of wealth. 

(a) Just what form of wealth does he produce? 

(b) For whom does he produce it? 

(c) Who produces the wealth I buy when I ride in the 
cars? 

lo. If we wished to be very precise, could we say that the 
miner of silver produces silver"? 

3. Narrow Meaning of Production. 
For most purposes, most economists nowadays use produc- 
tion in the broad sense already elaborated. In some connec- 
tions, however, we find it convenient to follow the popular 
usage which cuts off one class of producers from the rest, 
representing them as mediators between producers and con- 
sumers. I have in mind, of course, the exchanging class, who 
occupy a unique place in the system in that they appear at 
every stage in the long chain of processes leading from the 
first-stage producers to the ultimate consumer, mediating be- 
tween each member of the technical part of the series and his 
next neighbor. Thus they act as go-betweens between the 
stock-raisers and the tanners ; between the tanners and the 
shoemakers ; between the shoemakers and the shoe-warers. Ac- 
cordingly, we often find it convenient to use expressions like 
this : "It is the function of the exchanging class to correlate 

59 



PRINCIPLES OF ECONOMICS 

producers and consumers." That is, we sometimes use the 
term producers to include all sorts of contributors to the pro- 
duction of commodities and services except the exchanging 
class. No harm need result fi-om this, if we remember that 
in the deeper, larger sense, all who contribute in any kind or 
degree to the existence of utilities are producers. 

4. Special Antithesis of Productive and Consumptive. 

There is on narrow use of the adjective productive, though 
the verb produce has no corresponding use, which still has con- 
siderable vogue among economists. It is often criticised as in- 
consistent with the broad use of "produce" above explained, 
though, as it seems to me, without good reason. This use is 
illustrated when we say : "The communist wants to have all 
wealth, including consumptive goods, owned by the state, while 
the socialist would limit state ownership to productive goods, 
such as land used for productive purposes, machines, raw mate- 
rial, etc." In like manner, we call the services of the men 
whom Mr. Knickerbocker hires to work his mill productive, 
while the services of his coachman are unproductive or con- 
sumptive. It may be that, in the interest of clearness, we had 
better adopt a different phraseology; but I see no inconsistency 
between this antithesis of productive and consumptive and our 
definition of produce. This antithesis is concerned, not with 
the productive act, but with the destination of the product of 
that act. Of course, the coachman produces just as truly as 
does the mill hand ; but the thing he produces, his service, has 
a non-productive, rather than a productive, destination. 

Illustrative Problem. 

"This antithesis of productive and consumptive is all non- 
sense anyhow. So-called productive goods are merely consump- 
tive goods a little less ripe. The destination of all goods is to 
be consumed, — to contribute, directly or indirectly, to the satis- 
fying of wants." 

(a) Do you think this would be wholesome doctrine for a 
young man without any property starting out to make his way 
in life? Explain. 

(b) Use this to illustrate the discussion as to what is legiti- 
mate analysis appearing on page 

60 



CHAPTER 11. ANALYSIS OF PRODUCTION. 
Section E. Capital More Particularly Considered. 

In our discussion of the economic factors of production, we 
necessarily gave considerable attention to capital because of the 
controversies as to the propriety of counting it at all. We 
could not, in that connection, however, make our treatment any- 
thing like adequate without rendering it almost impossible for the 
student to get a comprehensive view of the whole matter of 
productive factors. Accordingly, we here return to consider 
some of the most important problems connected with this con- 
cept. 

1. The Special Function of Capital and the Capitalist. 

It has already been explained in a general way that capital, 
in the broader sense, has two functions in production, viz., 
(1) to wait and (2) to assume the final responsibility of pro- 
duction. The second of these is perhaps sufficiently plain. The 
first, which is the office of capital in the narrowest sense, needs 
some fuller treatment. 

If we ask ourselves for the proximate explanation of the 
superiority of capitalistic methods, we find it chiefly in the fact 
that through such methods man's very limited powers, capacities, 
are reinforced by capacities supplied to him by nature. Thus, he 
could do little toward cutting down a tree with his naked hands ; 
but those same hands, armed with a sharp stone or later with 
a keen-edged axe, find the task relatively easy. This process goes 
much further when man harnesses to his tasks great elemental 
forces like gravitation, as, for example, when he employs a 
water power. But, now, what is the peculiarity about the capi- 
talistic method of procedure which is necessary to enable it to 
bring to our aid nature's powers?- That peculiarity is this, that, 
in using said method, the producer reaches his goal by a round- 
about path. Instead of trying directly to accomplish his object, 
he first does several other things, — things which seem, perhaps, 
very little related to his ultimate object, but which are after all 
aimed toward that object in the strictest sense. Instead of try- 
ing to get down the tree at once, a man first sets about getting an 
axe with which to do the work. In the very highly specialized 
way that production is actually carried on, the woodman does not 
himself make the axe with which he cuts down the tree. But, 
looking at society as a whole, the cutting of the tree is the last 

61 



PRINCIPLES OF ECONOMICS 

of a long series of processes having no immediate connection 
with tree-cutting. Iron ore has to be gotten out, coal also, the 
latter turned into coke, this used with the ore in getting out pig 
iron, this transformed into steel and so on. Thus, it is dis- 
closed that roundaboutness is a necessity of the capitalistic 
method. 

But, again, it is plain that a roundabout method is usually, 
if not always, one which consumes more time than a more direct 
method. Of course, this does not mean that for the production 
of a certain definite amount — assuming it to be a large one — the 
roundabout method will necessarily prove to be the longer. On 
the contrary, it is probable that in the end that method will prove 
to have been much shorter. But, reckoning from the time when 
the first steps toward the goal are taken to the time when some 
returns, however small, are received, the roundabout method is 
almost always longer. If the primitive fisherman, so often used 
for illustration, wants food, he surely can get some in a much 
shorter time than it would take to make a net and a canoe and 
then use these to catch fish, though, of course, the latter method 
would enable him to catch ten thousand fish in a much shorter 
time than he could by some more direct method. If now it be 
conceded that capitalistic methods are usually time-consuming 
methods, it follows that the resort to these methods usually in- 
volves for producers an experience which to most persons is 
more or less of a sacrifice, i.e., waiting, — we must endure that, 
between the incurring of the labor sacrifices involved in pro- 
duction and the enjoyment of the fruit of those sacrifices, a 
considerable interval shall be placed.* 

Illustrative Problems. 

1. Suppose Mr. A has produced a hundred bottles of grape 
juice, which he must keep for ten years before drinking or sell- 
ing it, if he would get the very best wine out of it. 
, (a) If, now, Mr. B comes along and offers to give Mr. A 
100 bottles of wine zvhich had already been aged for ten years 
in exchange for the 100 bottles of grape juice, who would be 
doing the waiting? 



^Doubtless, this eleinent of waiting is in some degree present in every 
form of production; but it may be so small as to be almost negligible, and 
in so far as it is present in any particular case, the method of production 
is, strictly speaking, capitalistic. 

62 



CHAPTER IL ANALYSIS OF PRODUCTION. 

(b) What other costs of the production of wine would he be 
bearing? 

(c) Suppose Mr. B paid Mr. A the money price of 100 
bottles of wine for his grape juice, say, $100, who then would 
do the waiting? 

(d) If Mr. B borrowed the $100 from Mr. C, who would 
do the waiting? What other capitalistic burden would remain? 
Who would bear it? 

2. Even those of us who insist that it is, on the whole, best 
to distinguish land from produced intermediate goods, admit 
that the natural working of the laws of price, for the time be- 
ing, transforms land into capital. Explain this. (A piece of 
land yields a net money income of, say, $100 for an indefinite 
number of years. Will it be worth $100+$100+$100+$100H- and 
so on indefinitely? If not, what will it be worth?) 

3. One is sometimes temipted to say that the real nature of 
capital is best brought out by describing it as the power to 
own things. Argue for the usefulness of that way of looking at 
the matter. 

4. One writer is disposed to find the essential feature of cap- 
ital in this that it is superfluous wealth to its owner, — wealth 
which he can forego using. Show that this helps to under- 
stand the function of capital 

5. A good many American economists are inclined to look 
on capital, in one sense anyhow, as a fund of money value em- 
bodied in goods. That is, they prefer not to call the literal 
engine capital, but to reserve this word for the $2,000 of value in 
the engine. 

(a) How does this compare with business usage? 

(b) Does it seem natural or useful in any way? 

(c) Some who answer the last question affirmatively yet insist 
that such language is only figurative, and, besides, rather dan- 
gerous. Argue for both these points. 

6. One eminent economist proposed to include under capital 
only surplus supplies of subsistence. Another agreed with him 
so far as to affirm that all capital is, in the last analysis, redu- 
cible to means of subsistence, even food, — that, so to speak, the 
first incarnation of every new piece of capital is a surplus of 
subsistence. Probably the majority of economists would hesitate 
to go so far; but all would admit that there is some truth in 
this way of putting the case. 

(a) Show that, in a primitive community, the increasing of 
capital naturally begins with the accumulation of a surplus sub- 
sistence fund. 

(b) Argue for the proposition that there is a sense in which 
the whole stock of capital, engines, fuel, raw materials, etc., 

63 



PRINCIPLES OF ECONOMICS 

can be conceived as a subsistence fund. (Read Boehm-Bawerk's 
Positive Theory of Capital, pp. 321-322.) 

(c) On the basis of that conception of subsistence fund, 
argue for the proposition that new capital has to begin with a 
surplus subsistence fund. 

2. Is Capital Productive? 
Is capital productive? Is the capitalist a producer? These 
have been among the most troublesome questions of economic 
theory. This is due partly to the inherent difficulties of the 
matter, partly to its great practical significance. In the actual 
world, the capitalist proper, i.e., the person who does the wait- 
ing, and the entrepreneur capitalist have always received a very 
considerable reward for their reputed share in production. At 
the same time, there have arisen, in all ages, many protests against 
this order of things, particularly in the case of the capitalist 
proper. During many centuries, governments and the church 
stigmatized as wrong the taking of interest, and attempted to 
suppress it altogether. In modern times, the attitude of the 
authorities has changed and interest-bearing is practiced with 
general approval. Even yet, however, a considerable section of 
the population — especia'ly the advocates of socialism — believe 
that the capitalist gets a return to which he has no valid title. 
Naturally, these opponents make the alleged productivity of cap- 
ital their chief point of attack. Labor is the sole factor in 
production ; capital produces nothing and so has no right to 
share in the product, — is their contention. In addition to these 
opponents of interest, there are not a few professional econo- 
mists who, though looking on interest as perfectly legitimate, 
still deny that we can properly describe capital as productive. 
It is, therefore, almiost necessary, even in an elementary course, 
to give some attention to the problem. 

As already implied, the claim that capital is productive is 
attacked chiefly by two groups, vis., (l) those who think inter- 
est quite wrong, having no correspondence to any service of the 
capitalist, and (2) those who approve interest, attributing to the 
capitalist a service but not one which can properly be described 
as productive. As between economists generally and the first 
group, the difference is manifestly very real and fundamental; 
but, as between those who frankly call the capitalist productive 
and those who affirm that, although he performs a quite necessary 

64 



CHAPTER II. ANALYSIS OF PRODUCTION. 

service for which he can reasonably claim compensation, still the 
suppling of this service can not properly be designated pro 
duction, the difference is obviously one of mere words, or, at 
best, of mere theoretic precision. In the former case, it seems 
necessary to go into the matter somewhat fully. We can hardly 
afford to leave in doubt the question whether capitalists make a 
contribution to the productive process. The second controversy, 
however, can be left unsettled without materially affecting the 
student's comprehension of elementary economics. Its further 
consideration, therefore, will for the present, anyhow, be waived. 
Taking up, then, the quarrel with the socialists, does the cap- 
italist as capitalist perform any service, — make any contribution 
to the productive process? That the capitalist is a producer in 
one sense, viz., in the sense that, having bought the capital good, 
e.g., a net, he represents, performs by proxy, the labor necessary 
to produce the net, and, so, may reasonably enough be credited 
with so much of the product as is naturally credited to said labor, 
— so much all would admit. Thus, if the net costs 30 days of 
labor, lasts 90 days, and, in that time enables the fisherman to 
catch 9000 fish, making the average productive capacity of the 
120 days of labor 75 fish, then no one would object to saying 
that the net — and so the capitalist who owns it — produces 30 
times 75 fish or 2250; — no one would seriously object to saying 
this, though the socialist would prefer to say that the 30 da3^s 
of labor used in making the net really produced these 2250 fish. 
But I hardly need say that, in claiming that the capitalist as 
capitalist produces, we mean something more than this. In the 
actual world, the net or its owner, would be credited with more 
than 2250 fish, — let us say 2520 fish. But this would leave out 
of the 9000 for the 90 days of labor used in catching the fish 
only 6480 or 72 fish per day. But, if a day's labor had to be 
content with 72 fish when using a net, it would have to take the 
same pay when making one; i.e., the share of the total product 
credited to the net which would be credited to the labor spent 
in making that net would be only 30 times 72 fish or 216i0. Thus, 
out of the 2520 fish going to the net, there would be a surplus 
of 360 which would be credited to the net as something over 
and above the labor used in making it. This is something like 
the way things actually zuork. Now, the problem before us is 

65 



PRINCIPLES OF ECONOMICS 

this : Do these 360 fish which are credited to capital as capital 
represent, in some sense or degree, a contribution made by 
capital as capital? Granting that the word "produce" is not a 
good one, that the 360 fish going to capital as capital make too 
large a share, is it not, after all, true that capital as capital, 
that the capitalist as capitalist, has made some contribution to 
the result? It seems to us that the answer must certainly be 
an affirmative one. We will put the argument for it into a 
series of formal propositions. 

(1) Conceiving capitalistic production, as compared with 
non-capitalistic, to be merely a different method of utilizing 
labor, all admit that it is a more efficient method, — it gives a 
surplus of product over the non-capitalistic method. (2) The 
chQice of the more efficient capitalistic method involves the 
choice of a more time-consuming method. (3) The choice of 
this more time-consuming method necessitates an increase of. 
the waiting -sacriUce element which is involved in all produc- 
tion. (4) To this increase, (excess, surplus) of the waiting 
element must be credited, in a mere physical, technical sense, 
the increase in product effected by the capitalistic method; that 
is, this excess of the waiting phase of labor must be described 
as producing, in the technical sense, just as truly as does the 
effort phase of labor. (5) Unless the supply of waiting power 
is so great that we do not need it all, *.^., unless it is practic- 
ally a free good, such as air, then the assuming of the burden 
of waiting must be economically credited with at least some 
part of the increase in product due to the employment of the 
time-consuming method. (6) Finally, the supplying of this 
condition — the assuming of the waiting burden — is undertaken 
by the capitalist as capitalist and, therefore, the product credited 
to waiting must be credited to the capitalist as capitalist. 

3. Different Kinds or Forms of Capital. 
Up to this point in our discussion of capital, it has scarcely 
been recognized that any doubt could exist as to just what ought 
to be meant by the word capital. In fact, however, there is 
much controversy on this point. It would probably not be diffi- 
cult to distinguish as many as twenty different definitions of 
capital ; and in an advanced course, we could hardly pass this 
point without making a more or less thorough study of the 

66 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

question: How ought the word capital to be defined? But, 
at present such study would probably bring more confusion 
than enlightenment. Further, that study is the less necessary 
in that the differences of opinion on this matter are commonly 
much less important than at first sight seems to be the case. 
In fact, the same person may, and usually does, make more or 
less use of several of the meanings which he formally rejects. 
Accordingly, we shall not here attempt to settle the question 
of the proper definition of capital. We shall, however, discuss 
briefly the different kinds and forms of capital; and, in doing 
this, we shall incidentally bring out some of the more important 
variations from what may be called the orthodox definition of 
the term. 

(a) The definition which has been implied thus far in our 
discussion and which probably may fairly claim to be the most 
orthodox, makes capital to consist of intermediate products, or 
produced goods devoted to further production. Understanding 
capital in this sense, one of the oldest distinctions is between 
fixed and circulating capital. By fixed capital is meant capital 
like a tool or a machine, which gives off more than one service. 
Circulating capital, in contrast, is capital which does its part 
in a single use, — gives off hut one service, e.g., the raw material 
used in making a wooden box or the coal burned in a steam 
engine. 

(b) A second contrast is between specialized and general 
capital. Specialized capital is capital which is fitted for one 
purpose only or anyhow for a very few purposes, e.g., a planer, 
a copper stamper, a printing press.* Generalised capital is 
capital which can be put to any one of many uses, e. g., coal, 
pig iron, and, most of all, money. 

(c) A distinction which has already been brought out in 
another connection is between formal or money capital and 
real or goods capital. The fund of money or bank credit which 
the true capitalist is accumulating and which he or some bor- 
rower uses to buy capital goods may be called formal capital ; 
while the actual goods, the engines, machines, coal, etc., which 
are being produced to be sold for the money fund may be 
called the real capital. Here, however, the student must be 



^The term fixed capital is sometimes used in this sense. 

67 



PRINCIPLES OF ECONOMICS 

careful not to imagine that the person accumulating the money 
fund is not producing real capital. Ultimately, he is responsible 
for the existence of the real capital, the engine, machines, etc. 
The men who, literally speaking, produce those goods are virtu- 
ally only his agents. In a very important sense, he is himself 
producing those goods and lending them to entrepreneurs, 
though formally he lends a fund of money to entrepreneurs 
who thereupon buy the goods. 

(d) The preceding distinction of formal or money capital 
over against the real or goods capital suggests another closely 
allied one between invested and free capital. In view of the 
fact that, in the present order, the primary form in which capi- 
tal is accumulated is a fund of money^ it is natural, perhaps 
inevitable, that the process of devoting capital to a given 
enterprise should be described as putting it into, investing it in, 
the said enterprise. Accordingly, capital which has already 
been put to use is called invested capital; while that which is 
waiting to be put to use is called free capital* 

(e) Up to this point, we have had in mind a rather narrow 
concept of capital, viz., intermediate goods, products devoted 
to further production. If, now, we broaden our use of the term, 
as almost everyone does, to include all goods which serve their 
owner indirectly, i. e., by supplying him with other goods, thus 
making capital synonomous with income -getting goods, then it be- 
comes necessary to recognize another distinction between social 
capital and private or acquisitive capital. By the former is 
meant the kind of capital usually had in mind in preceding 
discussions, i. e., products used in producing other products. 
Such capital is income-giving even from the social point of 
view. By private or acquisitive capital, on the other hand, we 
mean capital which, though not used to increase the total volume 
of goods and so not income-bearing from the social standpoint, 
does yield an income to its owner, e. g., a gasoHne launch 
rented to a summer-resorter. 

(f) The distinction last commented upon arose because 
we extended the concept of capital somewhat beyond the strict 
grthodox limits. Obviously, we shall have other new distinc- 
tions arising if the concept is still further extended. One new 



•^Also frequently called idle capital. 

68 



CHAPTER 11. ANALYSIS OF PRODUCTION. 

way of conceiving capital, which with a number of economists 
has seemingly displaced the old idea altogether, makes capital 
to consist of a fund of valite embodied in the things commonly 
treated as capital rather than to consist of those things, them- 
selves. This way of looking at the matter some economists 
are disposed to admit, not as displacing the old concept, but 
as a more or less useful alternative. In such case, we have a 
new distinction of pure or value capital and concrete or goods 
capital* Even those who doubt the soundness of this distinction 
are almost compelled to use it more or less on account of the 
ambiguities in which current controversies have involved the 
word capital. 

(g) Some writers are disposed to extend the term capital 
to include durable products even when these are devoted to 
consumption, e. g., a dwelling house occupied by its owner. 
Though there is doubtless something to be said in favor of this 
practice, probably most of us think the older usage preferable. 
In some cases, however, we may find it convenient to speak of 
producers' capital, meaning the kind of capital originally had 
in mind, and consumers' capital, meaning consumers' goods 
which have a durable character, last for a long time, give ofif 
many uses. 

(h) As we learned earlier in the chapter, some economists 
insist on including land along with the goods usually desig- 
nated capital. This fact makes it convenient, sometimes, to 
distinguish natural and artificial capital. 

(i) It is occasionally convenient to speak of personal capi- 
tal, meaning the bodily or mental capacities and aptitudes of 
human beings ; though most economists consider such language 
figurative. Capital is only a kind of wealth or wealth looked 
at in a particular way. But personal capacities, not being trans- 
ferable, cannot have exchange value, hence cannot be wealth, 
and, therefore, cannot be capital. 

Illustrative Problems. 

1. "Is the ordinary laborer in any sense or to any degree a 
capitalist?" 

Give two or three reasons for an affirmative answer. 



*With those who adopt this notion of capital to the exclusion of the 
old, only value capital is capital at all. The engine, machines, etc., are 
merely capital goods. 

69 



PRINCIPLES OF ECONOMICS 

2. A man, let us suppose, has no tools besides his own hands, 
but uses these to pull the weeds and grass from about some 
wild strawberry plants which he finds already established. 

(a) Show that such a method of production is capitalistic. 

(b) S"how that it is capitalistic in that it involves the em- 
ployment of intermediate products. What is the intermediate 
product in this case? 

3. One man performs a certain amount of labor in connec- 
tion with a vineyard and has for sale a bottle of grape juice 
worth thirty-five cents. Another man does an equal amount of 
work, then waits five years, and has a bottle of wine worth one 
dollar ($1.00). 

(a) Show that the second process is more capitalistic than 
the first. 

(b) Precisely why does the more capitalistic method prove 
more efficient? 

4. Question : "How is it that capital increases the efficiency 
of industry?" 

Answer : "Capital is necessary to enable an entrepreneur to 
rent a site, put up buildings, and buy machinery and materials. 
Without capital he could not produce at all. So of course 
capital increases the efficiency of industry." 

Show that the answer does not go deep enough. 

5. Argue in favor of the contention referred to on page 69 
that we could reasonably include under capital durable goods 
which are devoted to supplying consumption service to the 
owner, e. g., a dwelling owned and occupied by himself. 

6. Give illustrations of your own of fixed capital, social 
capital, specialized capital, acquisitive capital. 

7. Argue for the contention that we should naturally expect 
the rate of interest to be determined in the first instance by the 
supply of, and the demand for, free, rather than invested, capi- 
tal. Would you expect the quantity of invested capital, repre- 
sented in buildings, engines, machines, etc., to have an indirect 
influence on the rate of interest? Explain. 

8. Why is it a natural metaphor to call an artist's skill his 
capital? 



70 






CHAPTER III. 

THE CONDITIONS AND LAWS OF PRODUCTIVE 
EFFICIENCY. 

It is hardly necessary to emphasize the point that all are 
interested in maintaining for the community a high degree of 
productive efficiency. Doubtless the extent to which individ- 
uals profit personally from such efficiency is subject to great 
variation. But we can scarcely conceive any one so situated as 
to gain nothing from it. Little defense, therefore, is needed 
for giving some attention to this topic. Here, however, a caution 
is needed. Political Economy does not attempt an exhaustive 
study of the conditions of productive efficiency. Such a study 
rather belongs to the technical arts, agriculture, mining, engi- 
neering, etc. Our task, in contrast, is to set forth the more 
general principles governing productive efficiency. 

Section A. Capitalistic Methods. 

In another connection, we have already brought out the 
nature of capitalistic production as being production wherein 
intermediate products play a part as well as nature and labor. 
In our day, practically all production is capitalistic production. 
But there are marked differences in the degree to which the 
industries of a particular city or country are capitalistic, as 
compared with those of another city or country, as also in the 
degree to which particular industries of one country are capital- 
istic as compared with other industries of the same country. A 
few industries, from their very nature, seem unable to use much 
capital. But, generally speaking, industries can commonly use 
about all the capital they can get. Further, in thus increasing 
the amount of capital employed, they seem able to increase their 
efficiency per unit of land and labor. The principal explanation 
of this increase in efficiency was brought out on pages . ., vis., 
the fact that through the roundabout method we are able to 
reinforce our powers with nature's powers. In the beginnings 
of industry, the gain thus achieved by introducing methods which 

71 



PRINCIPLES OF ECONOMICS 

are more capitalistic is simply enormous; e.g., making a net and 
boat and using these in catching fish instead of depending on 
one's hands alone. Even in later stages of development, some 
invention like the dynamo will give a startlingly great increase 
to our productive efficiency. This truth with respect to our 
dependence on capitalistic methods for high industrial efficiency 
is so familiar as to need little comment. Still it is not infre- 
quently overlooked in times of popular excitement; and legis- 
lative measures are adopted and enforced which discourage the 
accumulation of capital or drive it out of the community. It is, 
therefore, needful to have the general principle in mind. 

Principle. In general, the productive efficiency of any com- 
munity varies^ directly as the extent to which it employs capi- 
talistic methods. 

Section B. Specialized or Heterogeneous Cooperation. 

We have already seen that the present economic order is 
essentially a cooperative one, though the form of cooperation 
carried out in it is spontaneous rather than conscious and formal. 
We have also seen that most of the gain resulting from this 
cooperation is from the heterogeneous form, i.e., the form in 
which one person supplies one element; another person, another 
element; and so on, — in other words, the form of cooperation in 
which there is specialization. This specialization, I hardly need 
say, applies not only to labor but also to land and capital — 
though the conventional phrase, "division of labor," suggests 
that we have to do only with labor specialization. The student 
will have no difficulty thinking of many illustrations of land and 
capital specialization. Putting into formal shape this fact that 
specialized cooperation increases productive efficiency, we have 
the following 

Principle. In general, the productive efficiency of any com- 
munity varies directly as the extent to which specialisation in the 
use of different factors of production is carried. 

Among the considerations which explain the superior efficiency 
of methods involving such specialization, the following are of 
importance. 

*In economics, the phrase "varies as" does not involve proportionate 
variation. "To vary directly as" means to vary in the same direction, 
though not necessarily to the same degree. "To vary inversely as" means 
to vary in the opposite direction, though not necessarily to the same degree. 

72 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

(1) Specialization utilizes all instruments and agents, even 
the inferior ones. 

(3) It utilizes superior instruments and agents most fully. 
(The instrument capable of large work is not wasted on small 
things.) 

(3) It utilizes natural aptitudes (applying to lands and men). 

(4) It permits the creation of artificial aptitudes (applying 
to intermediate products and men). 

(5) It economizes in time (applying to machines and men). 

(6) It shortens apprenticeship (applying to men). 

(7) It stimulates invention and other improvements. 

It will be an excellent exercise for the student to work out 
illustrations of each of these advantages of specialization. 

The preceding discussion has emphasized he fact that special- 
ization — specialized cooperation — contributes greatly to productive 
efficiency. But, if specialized cooperation is conducive to produc- 
tive efficiency, then of course any condition which is requisite to 
such cooperation is conducive to productive efficiency. Now, as 
brought out at the very beginning of our study, exchange is such 
a requisite ; — under the present order cooperation is made pos- 
sible through exchange, trade. In order, then, to take advantage 
of the principle that specialization increases efficiency, we must 
exchange products with one another. But, further, the extent of 
the possible specializing is limited by the extent of the exchang- 
ing. If we trade with only a few people the need for a single 
kind of goods will be too small to justify setting some one per- 
son to producing that kind only. The amount wanted will not 
keep him busy. Hence, we have the following 

Principle. The extent to which specialization can proHtahly 
he carried varies directly as the extent of the market. 
, An obvious deduction from the principle just laid down is that 
anything which hinders trade between our town and other towns, 
or our state and other states, or our country and other countries, 
diminishes our productive efficiency in that it narrows the market 
of which we form a part and so diminishes the extent to which 
we can carry specialization. Hence we have the following 

Corollary. High productive eiUciency depends on a large 
amount of freedom of trade. 

It has not been possible to get thus far in our discussion of 

73 



PRINCIPLES OF ECONOMICS 

economic principles without bringing out by implication one of 
the principal reasons why economists as a class are free traders: 
— they favor the utmost possible freedom from restrictions, be- 
cause this means the largest possible amount of cooperation, — it 
enables every one to benefit most completely by the productive 
activity of every one else. But, while economists generally favor 
the utmost possible freedom of trade, we are all well aware that 
such freedom is decidedly the exception rather than the rule. 
Further, all economists would admit that this freedom is more 
important in some cases than in others; just because trade is 
more important in some directions than in others. It would be 
foolish to put an import duty on hay; but then it would do 
comparatively little harm for some years, since we do not nat- 
urally buy much hay outside our own country. Doubtless the 
economist would say that the trade — exchange-cooperation — which 
goes on of its own accord is the truly advantageous one ; so that 
we need not worry ourselves about the questions why and when 
is such trade advantageous, but would better simply leave the 
matter alone. But, whatever economists think, governments 
continue to try to guide our trade into more or less artificial 
channels. In doing this, they profess to act on the basis of 
principles. We have no intention of undertaking here a study of 
these principles. But one or two of them belong to our present 
topic in that they concern directly the question — when is 
exchange-cooperation, trade, between different countries, profit- 
able? To which question, therefore, we must now give a Httle 
attention. 

One general condition under which exchange-copoeration 
would surely be profitable would be realized if two communi- 
ties, Ci and C2, produced just two things. Pi and P2, and Ci 
could produce Pi much more cheaply than could C2, while Ca 
could produce P2 much more cheaply than could Ci. Evidently 
both would gain if Ci should produce enough Pi for both, and C2 
enough P2 for both. On the basis of this case, we might say that 
exchange will usually pay, if each of the exchanging countries 
can produce some particular thing much more cheaply than the 
other; and very likely the most important cases of profitable 
trade would be covered by saying that, when a country is abso- 
lutely superior to its neighbors in producing the goods it ex- 

74 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

ports and is absolutely inferior in producing the goods it imports, 
such export and import is profitable. 

But, while the most important cases of exchange-cooperation 
between countries would probably be covered by such a prin- 
ciple, fuller analysis long ago showed that this state- 
ment does not cover all cases, is in fact misleading. 
If we stopped at this, the reader might very naturally 
conclude that trade would pay only when the condition 
just explained was present. He might even conclude that we 
ought never to buy a thing from other countries if we could 
produce that thing as cheaply as those other countries. This 
notion, though quite wrong, is quite common. Thus, not long 
ago I had a conversation with a near neighbor which drifted 
into a discussion of Protection and Free Trade. The point which 
my neighbor was particularly disposed to insist upon was brought 
out in language something like this: "Of course I am glad to 
see the United States buy coffee of Brazil, for we can not pro- 
duce coffee at all. For that matter, I am willing to see our 
people buying silks, wines, and many other things I could men- 
tion, because other countries can produce those things better 
than we can. But the case of steel is a very different thing. I do 
not admit that there is any country under the sun that can 
produce steel any better than America can, so I am down on 
any tariff that lets in steel of foreign manufacture." Now, 
the unsoundness of the doctrine as applied to the case of an 
individual is at once evident. Here, for example, is a lawyer who 
very likely can mow his lawn, cultivate his garden, and take care 
of his furnace much better than the person or persons whom he 
hires to do these things. But what he does is to devote himself 
to the practice of his profession, and buy the services named 
from other people ; and of course acts wisely in doing so. Put 
in simple language, it is plain that he gains most by devoting 
himself to the doing of the thing for which he is best fitted, at 
which he can make the most money. He is not interested in 
the fitness or unfitness of his neighbor as compared with him- 
self, but rather in the superiority of his own fitness in one line 
as compared with his fitness in another line. So long as he can 
find a market for his possible output, he would better devote 
his time entirely to doing the thing for which he is preeminently 
fitted, and get his supplies of other things from his neighbors, 

75 



PRINCIPLES OF ECONOMICS 

even though he can make those other things better than his 
neighbors. 

Now, it seems pretty evident that the case of a community or 
nation is in this respect no different from that of an individual. 
The Upper Peninsula of Michigan produces little but copper and 
iron, getting most other goods through exchange with other 
communities. Yet it would be easy to prove that Upper Mich- 
igan is really better fitted to produce some of these things which 
she buys from the rest of us than we are, and that her people 
are quite aware of this. It is therefore necessary to find some 
other explanation of her action than the one commonly put 
forth by the public. This explanation is to be found in what has 
been long known as the Law of Comparative Cost. 
Principle. The Law of Comparative Cost. 

Ignoring cost of transportation, two communities (persons) 
find it proHtahle to specialize respectively in the production of 
two commodities and to exchange those commodities each for the 
other, provided the comparative real costs of the two commod- 
ities in one community are different from their comparative real 
costs in the other community. 

Illustration : Letting labor represent all real costs, suppose 
that in England the cost of a ton of iron is 25 days' labor and 
the cost of a yard of broa'dcloth is 5 days' labor ; while in 
America the cost of the iron is 16 days' labor and that of the 
broadcloth 4 days' labor. 

Eng. cost Iron : Eng. cost Cloth : : 25 : 5 
Am. cost Iron : Am. cost Cloth : : 16 : 4 
The comparative costs are not equal ; therefore, by the principle, 
specialization and exchange will pay. 

Argument : Since in England a ton of iron costs five times as 
much as a yard of cloth, it will naturally tend to be worth the 
same as £ve yards of cloth ; under which conditions England can 
afford to give iron for cloth if, and only if, she can get more 
than five yards per ton ; or trade cloth for iron if, and only if, 
she can get it with less than five yards per ton. In America, on 
the other hand, a ton of iron tends to be worth four yards of 
cloth ; under which conditions America can afford to trade iron 
for cloth if, and only if, she can get more than four yards per 
ton; or to trade cloth for iron if, and only if, she can get it with 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

less than four yards. But the first hypothesis for England and 
the second for America are plainly shut out. England can not get 
more than five yards of cloth for iron, since in America it is 
worth only four yards. So America can not buy iron with less 
than four yards of cloth since it is worth five yards in England. 
On the other hand, the second hypothesis for England and the 
first for America fit each other perfectly. England can get iron 
for less than five yards, since it is worth only four in America ; 
and America can sell iron for more than four yards of cloth, 
since it is worth iive in England. Accordingly, under the con- 
ditions supposed, an exchange of English cloth for American 
iron would be profitable. 

Note : The above statement of the Principle of Comparative 
Cost puts it in terms of the reciprocal trade of two countries. 
But in fact most international trade is not of this two-fold 
character. It is triangular or multiangular. Nation A sells to 
B; B sells to C; and C sells to A. At bottom, however, the 
cases are substantially alike. The condition which make special- 
ization and exchange profitable is a difference between the com- 
parative costs to one country of the things exchanged and their 
comparative costs to other countries. However, the complete 
demonstration of this proposition would occupy a good deal more 
time than we can spare and so must wait a more favorable 
season. 

Corollary 1. If one nation is absolutely inferior to its neigh- 
bors in respect to the production of one commodity and abso- 
lutely superior in respect to the production of another, then, 
obviously, the comparative costs of these commodities in this 
country are different from their comparative costs outside, and 
so exchanging them will pay. 

This corollary brings out the fact that the Law of Compara- 
tive Cost includes the general point first made that trade between 
two countries will pay provided each is superior to the other 
in respect to some commodity. 

Corollary 2. If ,a nation is absolutely superior to its neigh- 
bors in the production of each of two commodities, but its 
superiority is greater in respect to one than in respect to the 
other, it will profit by producing the former and importing the 
latter. 

Corollary 3. // a nation is absolutely inferior to its neigh- 
bors in the production of each of two commodities, but its 

77 



PRINCIPLES OF ECONOMICS 

inferiority is less in respect to one than in respect to the other, 
then it will proftt by producing the former and importing the 
latter. 

Illustrative Problems. 

1. In most economic text books, one meets the phrase 
"geographical division of labor." 

(a) What do you suppose it means? 

(b) Give some illustrations of it. 

2. Give some examples of recently developed labor special- 
ization, — if possible from your own observation. 

3. Same as Problem Z for capital. 

4. Why is it that a country store keeps a little of every- 
thing, while a city store very often deals in only one kind of 
commodity, e.g., shoes or china or sporting goods. 

5. Country A can produce pig iron at a cost of 10 days' 
labor per ton and broadcloth at a cost of 5 days' labor per 
yard. Country B can produce the iron at a cost of 14 days' 
labor and the cloth at a cost of 6 days' labor. 

(a) What, in this example, are the comparative costs which 
our principle tells us must be unequal to make exchange pay? 

(b) Prove in detail that, if transportation and all costs 
other than labor be ignored, exchange of these two products 
will pay. 

(c) Which commodity will country A export? 

6. Make a hypothetical case yourself and prove with it that 
exchange will not pay if comparative costs are equal. 

7. It is sometimes said that nowadays almost everything 
is produced for a world market. 

(a) What is one of the greatest gains of having such a 
market ? 

(h) What are some of tlie most important industrial changes 
which have made it possible? 

(c) Suggest one or two of the most serious evils which 
would naturally result from it. 

8. "We may often by trading with foreigners, obtain their 
commodities at a smaller expense of labor and capital than they 
cost the foreigners themselves." — Sumner. 

(a) Show with illustration that this is, true. 

(b) Show that in such case the foreigner would gain by 
keeping up the trade. 

(c) What do you suppose is the ultimate cause which ex- 
plains the fact that such trade can be profitable? 

9. "We know that England can make ships more cheaply 
than we can, and so we should let her do the ship building and 
turn our capital to such things as we can do better than she can." 

78 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

Assuming the conclusion — that we should turn our capital to 
other things — to be correct, the reason given for it is not 
entirely satisfactory. Explain. 

Section C. Large Scale Production 

It is a fact familiar to us all that the extraordinary industrial 
progress of the last one hundred years, and particularly of the 
last twenty-five years, has been accompanied by a great expansion 
in the scale on which industry is conducted. Further, it is 
generally recognized that in no small measure these have been 
related as effect and cause. The progress has largely resulted 
from the enlarged scale of industrial operations. The big 
store, the big factory, the big railroad is able to supply its 
particular product at much smaller cost and often of much better 
quality. Formally stated this gives us the following 

Principle. In general the efficiency of industrial units varies 
directly as their size. 

Among the principal reasons for this superiority of large 
scale production are the following : 

(a) Large scale production permits a great extension of the 
policy of specialisation in that it makes the number of neces- 
sary operations of any particular sort sufficiently large to keep 
a machine or man busy on that sort a^one. 

(b) Large scale production secures economy in the use of 
different factors, instruments. (1) At certain points specializa- 
tion must be carried almost as far in the small concern as in 
the large one; and the large one permits a fuller utilisation of 
the specialised factor. (2) In the stock of raw materials, tools, 
and finished products there must always be some reserves to 
meet contingencies. The reserves of a particular concern do 
not need to be five times as large as those of another concern 
though the business of the former is five times as large. 

(c) Large scale production makes it possible to utilize waste 
products. 

(d) Large scale production insures better bargains when the 
concern comes on the market as a buyer or seller. 

Caution: There seems to be a more or less definite limit to 
the size of the unit which can be effectively worked. This limit 
varies in different industries, at different times, and in different 
countries. It is soonest reached in respect to the physical unit, 

79 



PRINCIPLES OF ECONOMICS 

the plant. It comes much later in respect to the organization 
unit, the unit viewed as under one control in respect to manage- 
ment, accounts, buying and selHng, etc. There is probably a 
Hmit, however, at this point. A concern may become so large 
that the securing of honest and efficient management is well- 
nigh impossible. 

Illustrative Problems. 

1. Some of the big farms of East Prussia have their own 

little railways, locomotives, cars, etc. What advantage of large 
scale production does that illustrate? 

2. Suppose that the five banks of Ann Arbor were to be 
united into one and that, while each of the uniting banks em- 
ploys a cashier, a teller, a book-keeper, and a messenger, the 
consolidated bank were to employ a cashier, a paying-teller, a 
receiving teller, a discount-clerk, a collection-clerk, a head book- 
keeper, an assistant book-keeper, and a messenger. Show that 
the facts as stated illustrate two gains, of large scale industry, 

3. "If the four or five dry-goods stores on Main street vv^ere 
united, a great saving in the fund of circulating capital required 
in that business would be effected." (Circulating capital means 
capital out of which we get but one use, like food, or fuel, or 
goods which the merchant buys to sell again. In contrast, fixed 
capital gives off many uses, and, of course, remains in our hands 
some time; e.g., the showcases of the merchant. The things in 
the showcases are circulating capital.) 

(a) Argue for the truth of the quotation. 

(b) Show that the new plan would probably effect a saving 
in -fixed capital also. 

Section D. Industrial Freedom 

When the French Revolutioji broke out in the last years of 
the eighteenth century, it found most of the Western nations 
dominated by governments which exercised a very complete 
despotism, not only, in respect to matters commonly regarded as 
well "within the proper scope of political action, but also in 
respect to economic matters. Industry was regulated in the 
minutest way, — the amount each establishment could produce, the 
kind of stuff it should use, the methods of manufacture, 
(the number of threads to the square yard in cloth), these and 
many other matters were rigidly fixed by law and the regula- 
tions were enforced with great severity. It is probably true that 
in its beginning this excessive interference with the spontaneous 
course of industry was more or less justified ; but there early 

80 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

developed among business men and thoughtful students the 
notion that, as carried out, this policy was not only annoying 
and more or less inconsistent with our notions of right, but also 
a real hindrance to the attainment of the result sought. Nations 
were actually made less efficient and so poorer by the very 
means intended to make them efficient and rich. For various 
reasons this notion came to be widely accepted and incorporated 
into government policy near the end of the eighteenth century 
or in the early years of the nineteenth. And, whether as a re- 
sult of this change, or from other reasons, or from a combination 
of both, industry advanced at a quite unparalleled pace. In con- 
sequence, economists have come quite generally to hold the 
opinion that, whatever objections there -may be to it on other 
grounds, industrial freedom anyhow contributes to efficiency. 
Hence the following 

Principle. In general, industrial efficiency is greater under 
a regime of freedom, non-interference, laissez faire, than under 
one of much governmental regulation. 

Arguments : (a) Considerable freedom of trade, anyhow, is 
necessary if we are to have that thorough-going speciaU::ation 
which, as we have seen, contributes greatly to industrial efficiency. 

(b) Generally speaking, under freedom, the direction of 
industrial forces will be such as to secure the highest efficiency. 
(1) As a rule, individuals will be better able than any one else 
to decide what they are best fitted to do. (2) Individuals will 
have the strongest motives for seeing that they are doing those 
things ; since, however much advantage such a course brings 
to society at large, it brings still more to the individuals them- 
selves. 

(c) The stimulus of competition, emulation, is greatest under 
a regime of freedom. 

(d) The moral qualities requisite to efficiency, — self-reliance, 
decision of character, energy, industr}'-, etc., are most highly 
developed under freedom. 

Caution. (1) Advocates of non-interference have always 
recognized that more or less govermental interference will al- 
ways be necessary to secure the very industrial liberty they 
wish to see prevail ; since this liberty is liable to he restricted by 
private action, e.g., by the action of monopolistic combinations. 
In our day it has been found necessary to extend governmental 

81 



PRINCIPLES OF ECONOMICS 

action very far on this ground, — i.e.^ to extend that action in 
order to hinder private persons from encroaching on industrial 
freedom. 

(2) With the growth of popular control over govermental 
action, it has been found expedient to increase the activity of 
governments in directions which contribute indirectly to indus- 
trial efficiency, e.g., perfecting means of communication, supply- 
ing weather information, investigating industrial methods, parti- 
cularly in fields where there seems to be a lack of private 
initiative (agriculture), and so on. 

(3) Experience under the hisses faire regime soon showed 
that the high industrial efficiency secured by freedom might be 
purchased at too high a price. Excessive labor of women and 
children, physical injuries from improperly guarded machinery, 
and so on, called for, and secured, much remedial legislation. 
At the prejsent time there are still many abuses incident to great 
industrial liberty, the correction of which is much more important 
than the high efficiency derived from that liberty. It is probable, 
therefore, that for some time we shall not see less, but more, 
governmental interference with industry. Nevertheless, it still 
holds good that non-interference contributes to efficiency, and 
statesmen should carry out the needed control with a minimum 
of interference. 

Section E. Integration of Industries. 

In the preceding sections, we have discussed the conditions of 
productive efficiency with regard to which there is much con- 
firmatory experience and comparatively little difference of 
opinion. In this and the following sections we meet two alleged 
methods of increasing efficiency which are of recent origin and, 
in many minds, of doubtful value. One of these has been 
named the Integration of Industries. (See article in the Quar- 
terly Journal of Econornics, vol. 16, p. 94.) This new departure 
consists in the bringing together under one control of dissimilar 
but ijiter dependent industries ; e.g., a steel producer's under- 
taking to own and run iron mines, coal mines, coke ovens, pig 
iron furnaces, auxiliary railways, etc. This case of steel produc- 
tion was one of the first great applications of the principle; 
and, as all know, it was, and is, eminently successful. There 
seems little doubt, therefore, that the practice of thus combining 
interdependent industries is adapted, in some cases anyhow, 
to increase productive efficiency. Hence we are probably safe 
in laying down the following 

82 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

Principle. In many cases, industrial efficiency is increased by 
bringing interdependent industries under one control. 

Reasons: (1) Integration makes it possible to realize 
more fully the gains natural to large scale production. (2) 
Integration secures a variety of economies due to the comple- 
mental nature of the industries integrated, particularly in that 
each of these industries, save the lowest, provides a market for 
the product of some other member of the series and so saves 
advertising and other selling expenses, diminishes the risk 
burden, etc. 

Section F. The Unification of Industries: Consolidation, 

Combination. 

A very characteristic development of industry during the 
last twenty years, particularly in the United States, is the 
coalescing, combining, of hitherto independent industrial units 
of the same fzind into a single all-inclusive unite. Such units 
are commonly known as trusts, or, in popular phraseology, com- 
bines. The practice illustrated in their organization is contrasted 
with that covered in the preceding section under Integration, in 
that the latter combines dissimilar, though interdependent, units, 
while trusts combine similar units. An integration puts to- 
gether coal mining, iron mining, pig iron making, steel making, 
etc. A trust puts together the American Steel Company, the 
Carnegie Steel Company, the Illinois Steel Company, etc. 

Now it is fairly evident that the formation of a trust must 
in most cases realize one of the conditions of high efficiency 
already considered, i.e., largeness of scale, and, hence, it must 
so far tend to increase productive efficiency. Thus, the combina- 
tion bank in Problem 2, p. — , which takes the place of five 
independent banks, will obviously be five times as large as the 
average of the five, and its efficiency will be much greater than 
the average of the five. But, secondly, the combination unit 
will naturally have some advantages not necessarily belonging 
to a unit of equal size, derived from the fact that it is the result 
of combination, — that it has grown out of a variety of sources. 
Thus, different ones of the combining units may have developed 
specially efficient methods or machines which are more or less 
trade secrets,^ — and which will be much more fully utilized after 
the combination has been made than before — under an equally 

83 



PRINCIPLES OF ECONOMICS 

large unit which was a single unit from the outset, these would 
perhaps never have been developed. 

As a third advantage of combinations, it is always possible 
that the formation of a trust will establish a monopoly, complete 
or partial, in the industry involved. That is, said industry is liable 
to be brought under the control of a single will, natural or legal, 
which is what we mean by saying that a monopoly is established. 
Now, there can be little doubt that the men who seek to get a 
monopoly in any given case desire most of all to get into a 
position where they can regulate price in such a way as to 
secure the largest net return without respect to cost. But, while 
this doubtless is one of the chief hopes of monopoly creators, 
there is also ground for contending that monopoly in itself tends 
at some points to increase efficiency. The chief argument for 
this is that, under monopoly, there are a number of economies 
not possible to free competition. (a) Market expenses are 
smaller, because of diminished advertising, smaller number of 
salesmen, smaller time expense of selling, and so on. (b) Trans- 
portation costs are smaller because orders can be filled from 
the particular plant geographically nearest the consumer, (c) 
There is less risk of loss from failing to calculate correctly the 
demand in that a monopolist seeks to adjust production not to 
his possible share of a considerable demand — a quantity which 
it is extremely difficult to ascertain — but to the whole demand, — 
a quantity comparatively easy to approximate. 

We have seen that the combining of independent units may 
contribute to efficiency. But, of course, this is not the whole 
story. The influence of combination, particularly when it 
amounts to a monopoly, may be quite unfavorable to efficiency 
(a) First, there is likely to be less stimulus to enterprise, inven- 
tion, etc. The monopoly, when once established, tends to rest 
on its oars, (b) Secondly, it is very difficult to find administra- 
tive officials equal to the duties laid upon them in a vast business ; 
and this difficulty is greatly enhanced by the tendency to put 
into such places persons connected by family ties with the princi- 
pal owners of the business, without much regard to their fitness 
for the places in question. It is thus evident that combination 
is not always, or in every respect, favorable even to productive 

84 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

efficiency. Still we are probably justified in laying down the 
following 

Principle. Generally speaking, mere technical efficiency is 
usually increased by the consolidating of like industries under 
one control. 

Caution: It is hardly necessary to say that there are other 
aspects of the trust problem besides its relation to mere industrial 
efficiency. In so far as the existence of trusts m.eans the existence 
of monopolies, it obviousy limits that freedom of .competition 
which is depended upon to secure a right regulation of our 
economic activity. Further, that same element of monopoly 
gives the trust undue power over the whole industrial field. 
Fina'ly, it makes possible oppressively high prices. xA.ll these 
considerations may make it desirable, even necessary, to crush out 
the trust altogether, though some loss in efficiency will thereby 
result. Anyhow, there can be no doubt that it will be necessary 
to subject such institutions to a large degree of governmental 
control for the protection of society at large. 

Section G. EfHciency in Respect to the Entrepreneur 

Function. 

The preceding discussion of productive efficiency has set 
forth the more general principles of the matter. It still seems 
desirable to take up separately the particular functions involved 
in production and ask how efficiency is best secured in respect 
to those functions. Here we begin with the central, principal, 
function, — assuming the responsibility of production. 

In the first place, we need to distinguish the different kinds 
of entrepreneurs, vis., (a) the Individual Entreprenuer and (b) 
the Collective Entrepreneur. The collective class give us three 
subdivisions: (1) the Partnership, (2) the Joint-stock Associa- 
tion and (3) the Corporation. The partnership dififers from the 
other forms of collective undertaking in that its unity is 
unorganized, or anyhow very slightly organized, whereas 
both the joint-stock company and the corporation are 
consciously organized, i.e., provided with officials to whom are 
committed the different necessary functions, and in some of whom 
is placed the determining will, rather than in the members taken 
individually. While the joint-stock company and the corporation 
are alike in being organizations they differ, or at least earlier 

85 



PRINCIPLES OF ECONOMICS 

did differ, in that the corporation possesses the characteristic of 
limited liability; i.e., the members of a corporation are respon- 
sible for its debts, not to the full amount of their property, but 
only to a strictly defined amount, perhaps just what they have 
in the business or perhaps that and as much more. In earlier 
times, corporations came into existence only by a special act 
of the legislative authority; in our day they are usually formed 
by administrative process under the authority of a general law. 

Taking up, now, the question of efficiency with respect to the 
entrepreneur function, we note first that there are three chief 
requisites of such efficiency: (a) an adequate volume of capital, 
(b) enterprise, initiative, readiness to assume the responsibilities 
of production, and (c) judgment, foresight in recognizing good 
opportunities for undertakings. The third of these requisites, 
wisdom, foresight, is obviously in large measure a matter of 
endowment, though it is probable that education and the general 
dissemination of knowledge will be of use at this point. Again, 
the first requisite, an adequate volume of capital, will be discussed 
in the next section ; since the supplying of that capital is not the 
peculiar function of the entrepreneur, but rather of the persons 
whom we have called capitalists par excellence. Accordingly, in 
this connection we confine our attention to the second requisite, 
readiness of people to take the iniative, — assume the responsibility 
of production. This, however, requires little analysis or discus- 
sion, as the conditions of efficiency at this point are fairly obvi- 
ous. We may, therefore, summarize the whole matter in the 
following 

Principle. High productive efficiency in respect to the entre- 
preneur function, in so far as it is not a matter of natural en- 
dowment merely, depends chiefly on the maintenance of condi- 
tions zvhich (i) minimize the individual risk-burden of under- 
taking, (2) make possible the quick and easy entry into, and 
withdrawal from, enterprises, and (3) provide or permit large 
profits where risk is unavoidably great. 

Illustrative Problems. 

1. Something less than a century back, the unlimited-liability 
partnership form of cooperative undertaking was much the 
most common. Latterly, limited-liability organization has be- 
come very general. 

86 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

Show why one should naturally expect this change to con- 
tribute to productive efficiency, especially in the case of new 
enterprises. Illustrate. 

2. In our day every large city has a stock exchange where 
the shares of great corporations are daily bought and sold. 

How do such institutions contribute to productive efficiency? 

3. Give two or three ways in which patent right laws con- 
tribute to productive efficiency. 

4. There is much to be said in condemnation of our reck- 
lessness in permitting private individuals to exhaust our vast 
stores o'f natural wealth in gold, silver, oil, copper, etc. 

What can be said on the other side? 

5. Was there any excuse for the great liberality displayed in 
the granting of trolley car franchises in the late eighties? 

. 6. Argue for the contention that a much more efficient pro- 
tection of the public against dishonest promoters of mining and 
other enterprises would contribute greatly to productive effici- 
ency. 

Section H. Efficiency in Respect to the Capitalistic Function. 

It has already been repeatedly emphasized that capital is a 
very important factor in production. When we add that up to 
date there is still much controversy as to its precise nature, how 
it originates, how it is maintained, and so on, no excuse is prob- 
ably needed for giving it a fuller treatment than will be accorded 
the other factors in production. 

A very little reflection will make clear that efficiency on the 
side of capital involves chiefly three things: (1) An abundant 
stock, (2) availability, and (3) wise employment. The last of 
these depends mostly on the skill and capacity of the entrepreneur 
who determines what shall be produced and so determines to 
what uses capital shall be put. Accordingly, we are here con- 
cerned principally with the conditions on which we depend to 
secure an abundant stock of capital and to insure that that 
capital shall possess a high degree of availability. In dealing 
with the question : On what conditions must we depend for se- 
curing an abundant stock of capital, the first problem which 
meets us concerns the origin of capital. By what process or 
processes does it come into existence? To answer this question, 

therefore, must be our next task. 

87 



PRINCIPLES OF ECONOMICS 

1. How Does Capital Come Into Existence? 
It is too obvious to need serious argument that any piece of 
capital, say an engine, if viewed simply as a physical object, has 
to be brought into existence in just the same way as consump- 
tion products have to be, i.e., through consciously directed labor 
assisted by land and capital. Just as certain factories are en- 
gaged in making hats, golf balls, candy, and other consumption 
goods, so certain othef factories are engaged in making engines, 
machines, tools, and other capital goods. At first sight, then, it 
might seem as if such a factory was the place to study the ques- 
tion : "How Does Capital Come into Existence ?' In fact, how- 
ever, we are here concerned with something deeper than mere 
technical production. We are looking for the ultimate origin, 
the moral origin, so to speak, of capital. This is a legitimate 
question to ask with reference to any product; for under an ex- 
changing economic order, the technical producer of anything, 
whether it be an engine or a pound of candy, is not, in the most 
ultimate sense, responsible for its existence. He produces that 
engine or candy because he knows or expects that other people 
will buy it from him. He is in effect, therefore, acting as the 
agent of those people.* Now, in many relations this way of 
looking at the matter is of no interest to us ; but, in our present 
connection, it is very important. If we wish to know the ulti- 
mate origin of capital, we must go to the principal rather than 
the agent. Engines and other forms of capital are things the 
ownership of which involves keeping large amounts of value 
tied up all the time while getting income — service — therefrom 
only in small periodic returns. Not everyone, therefore, is in a 
position to buy and own such goods. How does the actual 
buyer get himself there? In this case the actual buyer is the 
is the entire preneur, who very likely has borrowed the money to 
make the purchase. Another step then is necessary. How did 
the man who lent the money to the borrowing entrepreneur get 
himse'f in a position to do this, i.e., in a position to give up, say, 
$3,0i00 in exchange for a yearly income of $150? The answer 
is plain he must have accumulated a money fund which was 

*This is evident enough in so far as production takes place to order; 
but the case is not essentially different when production is for a general 
market, — the latter type of production is possible only because experience 
shows that it will work substantially the same as if production were to order. 

88 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

to him for a longer or shorter period superfluous — i.e., could 
be spared from other possible uses. But the accumulation of 
such a fund obviously requires two things: (1) he must get the 
money, must from some source derive an income, and {2) he 
must save from that income, must practice abstinence. As far as 
the first condition is concerned, this must presumably be fulfilled 
in the same way that any income is obtained, i.e., he himself or 
his property must supply some service for which men are willing 
to pay a price. In doing this, he is virtually producing in the 
technical sense the goods capital which his money capital later 
buys. The second condition — saving — can have no deeper analy- 
sis. It is just saving, going without some gratification in the 
present which would otherwise have been possible. The capi- 
talist has a certain money income; he refrains from spending 
all of it consumptively; as a consequence he has a fund of 
money with which he himself, or someone to whom he lends it, 
can buy engines or other productive goods. As economic society 
is at present conducted, this is substantially the only process m 
which capital grows : get an income; save from that income. 
But to say that one saves from his income is to imply the 
existence of that income. It seems sufficient, therefore, to say 
that the process whereby capital is accumulated is saving. 

Principle. Under the existing economic order capital origi- 
nates chieUy in saving or abstinence. 

Comments: (1) In insisting that capital has its origin in 
saving, we must not forget what was said at the beginning of 
this discussion, that any concrete piece of capital has to be pro- 
duced, on its technical side, just as is any other piece of wealth. 
Under our system of specialization the technical producing of 
capital is, literally speaking, performed by someone other than 
the capitalist; but it surely has to be done. F'or some purposes, 
it is very important to fix our eyes on the money fund which 
the capitalist is accumulating as the thing to be recognized ab 
capital, the thing to be followed in tracing the genesis of capi- 
tal. But at this point we must be very careful. If we forget 
that, along with the accumulation of money funds, there must 
go on the manufacturing- of the goods capital corresponding, 
thereto, we are likely to fall into serious errors. Both these 
processes must be carried on if capital is to exist. Abstract 
or money or formal capital must be accumulated, and concrete 
or goods capital must be technically produced. In dealing with 
some problems, we must give our attention to money capital, 

89 



PRINCIPLES OF ECONOMICS 

with others our eyes are fixed on goods capital. But capital 
building, in the fullest sense, in our day requires that both be 
provided. 

(2). In the above discussion, saving is put forward as the 
true source of capital. Now, this word saving must not be 
understood as if it necessarily involved serious deprivation. 
Often this is not the case. For some men, spending rather than 
saving would bring the sacrifice. But, in any case, the relin- 
quishing of the right to spend for immediate satisfactions is 
necessary. 

(3). The antithesis between saving and spending which is 
involved in our account of capital building needs to be inter- 
preted with some care. Spending, as thus used, does not in- 
clude every case of exchanging money in hand for some com- 
modity or service, but only the exchanging of such money for 
consumption goods, goods of which we do not expect to make 
any other use than the direct satisfying of wants. Thus, to 
part with money in exchange for an engine to equip a factory 
would not be spending it in the popular sense or the sense here 
employed. Instead, such a use of money would be described as 
investing it. This is a distinction familiar to the business 
world ; but it is frequently overlooked and so becomes the 
source of a popular fallacy about money. (See Problem 5 
below.) 

Corollary. From the standpoint of people in general, the 
rich man zvho saves from his income is to he commended rather 
than the one who spends it on himself or his immediate de- 
pendents. 

Let the student give the argument. (Why may we expect 
that the increased efficiency will benefit people in general?) 

Meet the following objections: 

(a). If the rich man saves his money instead of spending 
it, there will be just so much less demand for goods in general, 
hence just so much less opportunity for employment. 

(b). If the rich man saves his money, instead of spending 
it, the consumption goods which were made but which he con- 
cluded not to buy will be wasted and the producer of those 
goods will be injured. 

Illustrative Problems. 

1. Suppose that a community of say 50,000 persons living 
on an island, completely isolated from all other communities, 
but otherwise living under an economic system like ours with 
division of labor, trade, metallic money, etc., should attempt to 
increase its capital by issuing $100,000 of paper money. 

90 



CHAPTER ril. PRODUCTIVE EFFICIENCY. 

(a) Argue for the contention that, in general, we should 
expect this attempt to fail. 

(b) Try to find some reasons for thinking that the scheme 
might realize a small measure of success. (Would said scheme 
tend to increase the total output of labor services? Would it 
tend to release any labor hitherto devoted to the old tasks?) 

(c) Change the hypothesis by supposing the given com- 
munity to be in free trade relations with many other communi- 
ties, and argue that the proposed issue would really increase 
the capital of the community. 

2. "When the primitive fisherman refrains from eating fish 
in order to accumulate a store to be eaten while he makes a 
net, we obviously have a case of real saving. But when a 
capitalist keeps his money rather than spending it, things are 
very different. The good things our capitalist refrains from 
consuming have not been made at all ; instead, producers, 
knowing that capital is being accumulated, are making engines, 
cars, etc., which obviously could not be consumed. But, if 
they could not be consumed, they could not be saved, such 
capital, therefore, does not result from saving." 

Taking as your definition of saving this : "Saving is going 
without something one might otherwise enjoy," show that the 
capitalist who accumu'ates a fund of money does really save. 

3. Suppose that, instead of proceeding as at present, the 
capitalist were himself to make the concrete pieces of capital, 
hoes, plows, planes, engines, etc., and then lend these to pro- 
ducers for hire. Would such making of capital involve saving? 

4. Suppose that a communistic state, in order to increase its 
stock of capital, should proceed to require from every citizen 
one more hour of labor daily. Would this way of building 
capital involve saving? 

5. "A wise government will never let a dollar in money go 
out of the country ; for, as every dollar spent by an individual 
makes him so much poorer, so every dollar paid out by the 
country to other countries makes the first country so much 
the poorer." 

(a). In what sense must the word "spent" be understood 
to make the case of the individual and the country parallel? 

(b). When used in this sense, is it true that every dollar 
spent by the individual makes him so much poorer? 

2. Conditions Favoring the Accumulation of Capital. 
We have seen that, under present-day conditions, capital 
comes into existence chiefly through saving, abstinence — a de- 
liberate relinquishment of the present disposal of mcome. What 

91 



PRINCIPLES OF ECONOMICS 

conditions favor the practice of this line of conduct? A fairly- 
adequate general answer can be put into a single sentence. 

Principle. The accumulation of capital is favored by the 
existence of large incomes, by conditions which insure to capi- 
talists the expected advantages of saving, and by the presence of 
, suitable social machinery to aid in caring for, and investing, 
accumulations. 

Illustrative Problems. 

1. Give reasons for expecting capital to accumulate more 
rapidly in England than in Scotland ; in Germany than in 
Persia. 

2. Suppose the total income of industry in the United States 
were divided equally among all the citizens, do you think capi- 
tal would grow as rapidly as it now does? Why? 

3. Explain why. postal savings banks would be expected to 
increase the accumulation of capital ; same for loan and trust 
companies ; same for insurance companies. 

4. From our present standpoint, argue for or against the 
Oklahoma system of guaranteeing bank deposits. 

3. Conditions Favorable to Rendering Capital Available. 

It hardly need be said that mere accumulation of capital is 
not enough ; if it is to do its part, it must be made available. 
At this point modern business methods have been wonderfully 
successful. We are able to utilize not only the more considera- 
ble funds which people have definitely set apart to play the 
role of capital, but also a great amount of wealth which is onV 
momentarily idle and could not be treated as capital at all, 
were it not for modern institutions of credit. 

Under present-day conditions, capital is chiefly utilized by 
persons other than those who accumulate such capital, i.e., 
the entrepreneur is a different person from the capitalist proper. 
Consequently, availability means making the process of lending 
and borrowing easy. Here, as under the preceding head, the 
general conditions can be put in a sentence. 

Principle. The availability of capital depends on a high state 
of entrepreneur credit and high eMciency in the institutions 
which deal in money capital, — hanks, trust companies, and so on. 

Illustrative Problems. 

1. For some years before and after 1892, it looked to 
European observers as if the United States were likely to give 

92 



CHAPTER III. PRODUCTIVE EFFICIENCY. 

up the gold standard and adopt silver, thus reducing the value of 
the dollar, as most expected, by about forty per cent. What 
effect would you expect this condition to have on foreign cap- 
ital in the United States? 

2. The existence of the ordinary commercial bank enables 
us to make available quantities of money capital out of funds 
which are not really set aside for use as capital, but rather are 
being kept for daily use. Try to explain how that can be. 

(Suppose that 500 persons kept the funds which they expect to 
put to everyday use in a bank, and make payments partly by 
cash drawn out, partly by checks drawn in favor of one 
another. Show that the bank could safely treat a considerable 
part of the funds as if they were going to be permanently 
idle.) 

3. In Germany there are many agricultural loan associations 
which issue jointly-guaranteed bonds to the lending public, then 
lend to their members on ordinary mortgage security. Does it 
seem likely that this system would tend to make capital more 
available to farmers? 

4. Look up the Torrens' Land Title system (some cyclo- 
pedia), and see if its adoption would tend to increase the availa- 
bility of capital. 

Section I. The Efficiency o£ Labor. 

(See Reading VIIL) 

It is a matter of common knowledge that there are great 
differences between different countries in respect to the effi- 
ciency of labor. The causes of these differences are in part 
natural and so in the main irremovable. Inherited traits, 
physical, mental, moral, must keep the East Indian inferior to 
the English or American laborer for many generations any- 
how. But there are other particulars wherein the conditions 
of labor efficiency are more or less controllable through legisla- 
tion or individual action. In part, we can trust the natural 
working of self interest in employers and laborers to secure 
these conditions, especially as the diffusion of knowledge makes 
evident the reality of these conditions. But, in not a few par- 
ticulars, it has proved necessary to interfere through the strong 
hand of the state to protect the general social interest m highly 
efficient labor, from suffering at the hands of greedy, short- 
sighted employers and laborers. 

The most important conditions of high labor efficiency are 
suggested in the following statement. To secure high labor 

93 



PIRINCIPLES OF ECONOMICS 

eMciency, we need (a) material conditions fitted to insure vigor 
of body and mind, (h) political and social conditions which coa- 
tribute to the development of self-respect, ambition, and so on, 
and (c) some system of remuneration which is fitted to encour- 
age industry, carefulness, energy, and so on. 

Illustrative Problems. 

1. It is often said that the Irishman is a lazy and incapable 
laborer at home, but fairly, even highly, efficient in America or 
Australia. Can you suggest some explanation of this? 

2. Look up the profit-sharing system (there are various 
books on the subject — Oilman's among the best), and argue that 
it is likely to increase the efficiency of labor. 

3. Compare with respect to probable efficiency, giving reasons 
therefor : the slave system, the time-wage system, and the 
piece-wage system. 

4. Argue for and against, the tendency of general educa- 
tion to increase the efficiency of manual laborers. 

5. Give some reasons why we cannot safely leave the proper 
regulation of child labor to free contract. (See Reading VIII; 
also Mill, Book V, Chapter XI.) 



94 



CHAPTER IV. 
COMBINING PROPORTIONS AND PRODUCT. 

It is a fact too evident to need argument that substantially 
all productive processes are joint processes, — processes wherein 
two or more factors cooperate in accomplishing the result. 
Land by itself can produce no considerable quantity of potatoes ; 
labor by itself can produce none; a furnace can not give out 
heat without coal ; feeding the coal to the furnace needs labor ; 
and so on. 

Again, it is too evident to need argument that the produc- 
tivity of any joint or cooperative process varies more or less 
with changes in the combining proportion. Thus, increasing the 
quantity of labor used in cultivating a certain piece of land 
might make the total product greater or might leave it just the 
same or might even make it smaller. Further, in case it made 
the product greater, the increase might be in exact proportion to 
the increase in labor or it might be in a larger or smaller pro- 
portion. Similar statements could be made of other combinations 
of factors, say a locomotive and the coal used in firing it. If 
we had just started the fire, a certain increase in the coal fed 
might increase the water evaporated much more rapidly than the 
increase in fuel consumption. At a later stage, there might be 
an increase in water evaporation, but one which was less than 
proportional to the increase in fuel consumption. Still later the 
increase in fuel consumption might bring no increase in evapora- 
tion ; and, finally, might even diminish it. 

Now, in the main, this question of combining proportions is a 
matter of industrial technique rather than of economic science. 
But several problems which it suggests are of the utmost im- 
portance in strictly economic connections. Thus, the ultimate 
basis of a comunity's economic capacity, its store of natural re- 
sources, — the land it controls, — is definitely limited in amount, 
while population and capital can, and do, increase ; in thus in- 
creasing, they alter the proportion in which the several factors 
of production are combined ; and the effect of this in changing 

95 



PRINCIPLES OF ECONOMICS 

the rate of output is obviously a matter of great moment. Will 
the additions to capital and labor increase product at all? If so, 
will the increase be just proportional or more than proportional 
or less than proportional? These are all questions which ob- 
viously have a marked bearing on human welfare. It is, there- 
fore, very important that we get a clear knowledge of the more 
fundamental principles with respect to the effect rpon ])roduct 
of changes in combining proportions. 

Section A. Principles Governing the Combining of Individ- 
ual Factors. 

The more important problems of combining ratios arise when 
we bring together total stocks of the several factors, e. g., the 
whole land outfit of England over against its outfit of capital or 
labor or both. But we must find our fundamental facts in the 
relations between particular pieces of land, of capital, and of 
labor. We must first know how individual units of Idud and 
labor, or of capital and labor, or of land and capital, behave 
when combined in different proportions. To make she problem 
as simple as possible, let us begin with a series of hypothetical 
combinations made up of two elements each of wiiich is divisible 
and substantially homogeneous,* and assume that certain con- 
Having obtained from these hypothetical experiments definite 
notions of the principles and relations involved, we will then 
show that actual experience confirms our assumptions. 

Let us begin by representing the two factors which we are to 
experiment with by the letters A and B. Let us "suppose our- 
selves to start with a large amount of A and a very small one 
of B, and to increase the amount of B in successive experi- 
ments while A remains constant. Further, let us assume that 
the results of our experiments are as follows: (1) During 
the first few experiments, output increases and that more 
rapidly than does the changing factor, B ; (2) during a number of 
experiments next following, output continues to increase but 
less rapidly than does B; (3) during the remaining experiments, 
output actually diminishes. In order to give definiteness and 
clearness to our ideas, these imaginary experiments and re- 



*Such a case might be roughly realized in the relations of a piece of 
farm land substantially uniform in respect to quality, position, etc., and a 
quantity of labor devoted to cultivating said land. 

sequences will follow a changing of the combining proportions. 

96 



CHAPTER IV. COMBINING PROPORTIONS. 

suits are presented in numerical form in Table I. The fig- 
ures given are of course purely imaginary, as are the 
combining elements, A and B. No known combination could be 
represented in just this way. But a careful study of some such 
table is after all well-nigh essential to a clear understanding of 

the real cases. 

TABLE I. 

I II III IV V VI VII VIII IX 



1^ 






O 






5> 


5^ 




Margina 
Product 
of ^'s 


1 


20 


2 


2 


. . . 


. . . 


.1 


1 




1 


2 


20 


3 


6 


1 


4 


.3 


2 




4 


3 


20 


4 


16 


2 


10 


.8 


4 




10 


4 


20 


5 


35 


4 


19 


1.7 


7 




19 


5 


20 


6 


84 


7 


49 


4.2 


14 




49 


6 


20 


7 


126 


14 


42 


6.3 


18 




42 


7 


20 


8 


156 


18 


30 


7.8 


19. 


5 


30 



8 20 9 179 19.5 23 8.9 19.8 23 



9 


20 


10 


200 


19.8 


21 


10 


20 


21 


10 


20 


12 


236 


40 


36 


11.8 


19.7 


18 


11 


20 


14 


266 


39 


30 


13.3 


19 


15 


12 


20 


16 


290 


38 


24 


14.5 


18.1 


12 


13 


20 


18 


312 


36 


■ 22 


15.6 


17.3 


11 


14 


20 


20 


330 


34 


18 


16.5 


16.5 


9 


15 


20 


22* 


346 


36 


16 


17.3 


15.6 


8 


16 


20 


25 


362 


43 


15 


18.1 


14.5 


5.5 


17 


20 


28 


380 


58 


18 


19 


13.3 


5 


18 


20 


33 


393 


63 


13 


19.7 


11.8 


2.8 


19 


20 


40 


400 


79 


7 


20 


10. 


1 



20 20 44 398 44—2 19.8 8.9 — .5 

21 20 50 392 50—5 19.5 7.8 — 1 

22 20 57 360 56 — 33 18 6.3 — 4 

23 20 66 280 60 — 80 14 4.2 — 8 

24 20 80 140 56 —140 7 1.7—6 

25 20 100 80 35 — 60 4 .8—3 

26 20 133 40 106 — 40 2 .3—1 

27 20 200 20 20—20 1 .1 — .3 



''In this and a number of other cases, the figure is slightly inexact. 

97 



PRINCIPLES OF ECONOMICS 

In this table the first column shows the number of the com- 
bination ; the second, the amount of A's in the combination ; the 
third, the amount of B's ; the fourth gives the output or product 
for each combination ; the fifth shows what the increase in output 
would be if it were proportional to the increase in B's ; while the 
sixth shows the actual increase.* Comparing columns V and VI, 
we see that increases in output are more than proportional up to 
Combination 9 ; less than proportional from 9' to 19 ; and turn 
into decreases from 19 on. That is, looked at from one point 
of view anyhow, the different combinations naturally break into 
three stages or groups, which stages may be characterized as 
follows : (1) Output increasing more than proportionately or at 
increasing rate, (2) output increasing less than proportionately 
or at diminishing rate, (3) output diminishing. 




*The remaining columns will be explained later. 

98 



CHAPTER IV. COMBINING PROPORTIONS. 

The results of this analysis of our table can be presented 
graphically as in Diagram I. The vertical spaces counting from 
left to right represent the successive combinations. The diagram 
shows a series of dots connected by a continuous line and another 
series each of which is connected to some member of the first 
series by a short spur. The vertical distance of any dot in the 
continuous line above the preceding dot in that line shows the 
actual increase in product. The vertical distance of the dot 
attached by the spur to the same preceding dot from said pre- 
ceding dot shows what would have been a proportionate increase 
in product. It will be noticed that up to combination 9, all the 
proportional increase dots are below the actual increase dots ; 
while all after 9 are above. Beyond 19 the increases are turned 
into decreases. 

Notes: (1) As wiil presently appear, the combinations which 
range from 9 to 19 are, for divisible factors, the only practicable 
ones. This stage, therefore, is in such cases the one to which 
we have most frequent occasion to refer. Unfortunately, con- 
ventional usage designates it as the stage of diminishing returns, 
and we can scarcely hope to reform this usage. It is, however, 
of great importance that we realize that this is not a stage of 
diminishing returns, but rather one of returns increasing, but 
not proportionately. During this stage, we can get more out 
of our stock of A's by increasing the proportion of B's ; but 
not as much more as the amount of B's added might lead us to 
expect. 

(2) In conventional phraseolog}^ Combination 9 is calbd the 
point of diminishing returns. A man working A's in Combina- 
tion 12 would be described as working them be3'-ond the point 
of diminishing returns. 

In the series of imaginary experiments just analyzed, Factor 
B was increased with each experiment. It is obvious that, if 
the results of said increases are as indicated, decreases would be 
followed by opposite results ; that is, we can read our table up 
as well as down. So read, it gives the following result : If we 
start with one of the factors in great excess and diminish that 
factor in successive experiments, the results will break into three 
stages as before: (1) output increasing; (2) output diminish- 
ing but less than proportionately ; 'and (3) output diminishing 
more than proportionately. This way of looking at the matter 
is important as furnishing an additional test as to the stage in 
which a factor or an industry is to be found. 

Problem : Let the student compute two additional columns 

99 



PRINCIPLES OF ECONOMICS 

for Table I, to be read from the bottom up, showing (1) what 
the decrease in output would be if proportional to the decrease 
in B's, and (2) what the actual decrease is. 

In the foregoing presentation of the facts brought out in our 
table, we have compared the actual increase in output as factor 
B has increased with an increase which would have been pro- 
portional to the increase in B. Another quite important method 
of presenting these same facts sets forth the changes which fol- 
low the successive increases in B in respect to the average output 
measured in either A or B. The figures for these averages are 
found in Columns VII and VIII of our table. Since, from Com- 
bination 1 to Combination 9, the total output is increasing, the 
average per unit of A's is, of course, rising during that stage. 
Further, since the increase is more than proportional to the in- 
crease in B's, the average measured in B will also rise. That is, 
the first stage is one in which averages increase measured in 
either factor. From Combination 9 to 19, the total still increases 
and so the average measured in A increases ; but, as the increase 
is less than proportional to the increase of B, the average meas- 
ured in B is diminishing. That is, the second stage is one in 
which the average, measured in the constant factor, increases, 
but, measured in the increasing factor, diminishes. From Com- 
bination 19 on, since the total falls off, the average diminishes 
measured in either factor. It follows that, from this standpoint 
of averages, the series breaks into three stages as before: (1) 
both averages increasing, (2) averages increasing-diminishing, 
and (3) both averages diminishing. From this point of view, it 
is also important to note that the combinations which ' form 
boundaries between the first and second and between the second 
and third stages, viz., 9 and 19, are maxima combinations, i. e., 
in 9 the total return, measured in B, is the largest possible, while 
in 19 that return, measured in A, is the largest possible. This 
supplies a possible nomenclature for the several stages: (l) 
ante-maxima, (2) inter-maxima, and (3) post-maxima. 

These facts with respect to averages can be effectively pre- 
sented by graphic methods. In the accompanying diagram, the 
figures at the top show the number of the combination, the 
rectangles included between the base line X-X and the continuous 
curve represent the output for the several combinations averaged 
for a unit of B, while the rectangles included between the base 

100 



CHAPTER IV. COMBINING PROPORTIONS. 

and the dotted curve represent the output averaged for a unit of 
A. The heavy verticals at 9 and 19 indicate the maxima for B 
and A respectively. The course of the curves shov/s graphically 
hew the output measured in either factor increases up to com- 
bination 9 ; how it then declines when measured in B, but i-till 
increases as measured in A up to 19 ; and how, iinally, it de- 
clines, as measured in either factor, from 20 to the end. 




X 



Note : The preceding analysis suggests that we may properly 
designate Combination 9 as the one of maximum efficiency— 
from the standpoint of the constant factor — or as the one of 
maximum returns — from the standpoint of the changing factor. 
So, Combination 19 is the one of maximum returns for the con- 
stant factor or of miximum efficiency for the changing lactor. 

In addition to the preceding methods of bringing out the 
facts of our table, there is still another which must not be over- 
looked. In column IX, which has thus far been disregarded, we 
have a series of figures which indicate what is commonly known 
as the marginal product of the changing factor, B. Thus in the 
second combination there is one more unit of B than in the 
first, while there are four more units of product. The ninth 
column, therefore, has for this combination a 4, — the amount 
which the last or marginal unit of B adds. So, in the third com- 
bination, we have one more B, while product is ten units gi eater; . 
the last column, therefore, shows for this combination a 10, — the 
amount added by the last B. Now, if we examine this columm, 
we see that the marginal product increases up to Combination V; 
that it then diminishes down to 19 ; that from 20 on ir is less 

101 



PRINCIPLES OF ECONOMICS 

than nothing. Looked at from this standpoint the combinaticns 
show three stages as before ; but the two sets do not exactly 
correspond. We might call these: (1) the stage of increasing 
marginal productivity, (2) the stage of diminishing productivity, 
and (3) the stage of negative productivity. The last corresponds 
to the third stage of the other methods of analysis ; but the 
boundary line between the first and second is at 5 rather than 9. 
However, there is also a possible break at 9 in this column. 
From that point the diminishing marginal product falls below 
the previous average, as well as below its immediate predecessor. 
The preceding paragraph gives us a new way of describing 
Combination 19. Instead of calling it the point of maximum re- 
turns for A, we may call it the point of minimum marginal 
productivity for B. That is, our combination contains all the 
B's it will stand. Any addition to the proportion of that factor 
will reduce rather than increase product. Its marginal productiv- 
ity in the next combination is less than nothing. 

The points which have just been brought out in our imaginary 
experiments are capable of expression in another way which for 
some purposes is more convenient and so is much used. It 
should, therefore, be explained at this point. In our table from 
the beginning to Combination 9, the amount of A remains con- 
stant, while the amount of B increases less rapidly than the 
output does. Under these conditions, whatever be the price of 
A's and B's, the cost of each unit of output will decline. Con- 
versel}^ when from 10^ to 19 the A's remain constant and the B's 
increase more rapidly than output, the cost per unit of output 
will constantly increase. It follows, accordingly, that we can 
state the principle already brought out, partly at least, in terms 
of changing cost. So stated, it would read, that if we attempt 
in successive seasons to increase the output from a given com- 
bination by increasing the proportion of one of the factors from 
zero up, while leaving the other constant, we shall strike at least 
two stages and one turning point, (1) a stage of diminishing 
cost, (2) a point of minimum cost, and (3) a stage of increas- 
ing cost. 

Illustrative Problems. 

1. (a) If you had 20- A's and 7 B's would you use Combina- 
tion 6 of Table I or some other? 

(b) How would you act if you had 20 A's and 50 B's? 

102 






CHAPTER IV. COMBINING PROPORTIONS. 

(c) What general conclusion with respect to the profitable 
combinations can you make in view of your answers to (a) and 
(b)? 

2. (a) Suppose you had at your disposal more A's than you 
could- use, but your stock of B's was smaller than your needs; 
what combination would you naturally use? 

(b) Reverse the places of A and B, and answer the above 
question. 

3. (a) If you had to pay $2 apiece for A's and $1 for B's, 
which combination would you find it most profitable to use? 

(b) Reverse the prices and answer the question. 

(c) What generalization can you make on the basis of these 
two answers ? 

4. The combinations of our table from 1 to 8 have an excess 
of A's ; those from 20 to 27 have an excess of B's. How would 
you describe those from 9 to 19, from this same standpoint of 
the excess of one or the other factor? 

5. Combination 9 gives us the point of maximum efficiency 
for A's, and that of maximum returns for B's. Combination 19, 
on the other hand, gives us the point of maximum returns for 
A's and that of maximum efficiency for B's. 

Explain fully what these statements mean. 

6. "It can never be profitable to carry the utilization of any 
factor, say A in our table, beyond the point of diminishing re- 
turns." Refute this statement. 

7. I am sometimes disposed to call the stage from Combina- 
tion 9 to 19 the stage of diminishing efficiency. Argue for the 
reasonableness of this designation. 

8. We often speak of cultivating the land more and more 
intensively. Suppose A in our table to be land, and point out 
what combinations would involve intensive cultivation. 

9. What would you naturally tmderstand the expression, 
"lower the margin of cultivation," to mean? 

10. It is believed by a large number of economists that the 
wages of laborers will tend to be the amount, of product which 
the marginal laborer of their class adds to the total, or, briefly, 
will tend to be their marginal product. Accepting this doctrine 
as true, and supposing that our A represented land and our B's 
laborers, and we were dealing with a small isolated island con- 
taining 20 units of land and 10 laborers, how many units of 
product would each laborer tend to get? How many, if there 
were 12 laborers? 14? 17? 

11. (a) Does the designation, "the stage of increasing re- 
turns," suggest to your mind that the first of our stages is the 
most desirable one to be working a piece of land in? 

(b) Is it? 

103 



PRINCIPLES OF ECONOMICS 

(c) What does the phrase "ante-maxima stage" suggest to 
your mind? 

In the preceding series of experiments, A was supposed to 
remain constant while B increased. If, now, we were to reverse 
the hypothesis, keeping B constant and increasing A, v/hat re- 
sults would we have? Precisely similar ones to those already 
brought out, with the places of A and B reversed. That is, for 
a time output would increase more than proportionately to the 
increase in A, then would increase less than proportionatelyy, and 
finally would diminish. And this is not a new principle based 
upon a new induction. On the contraryy, a table reversing the 
relations of A and B both as to conditions and results is directly 
deducible from the table already given. First, the averages given 
in Columns VII and VIII would of course result from all com- 
binations showing the same ratios of A and B, whatever the total 
of said combinations. Thus, Combination 5 — 20' A's to 6 B's — 
gives a B average of 14 and an A average of 4.2 ; and the result 
would be the same, if the combination were 100 to 30 or 40 to 12 
or 30 to 9 or any other embodying a ratio of 10 to 3. We can, 
therefore, make a table showing just the same averages for each 
combination hy diminishing A's rather than increasing B's, pro- 
vided, of course, we reproduce the same combining ratios. Sec- 
ondly, we can compute from these averages the Lotal output 
from each combination. Third y, we can begin at the bottom 
of this table, thus making A an increasing factor, and compute 
proportional and actual increases in product just as in our first 
table. Carrying out this plan gives us Table II. 

In this table we start with 200 A's and 20 B's, a combination 
which embodies the same combining ratio as Combination 1 of 
our first tab'e, and diminish the A's each time ju.st enough to 
reproduce exactly the ratio of the corresponding combination 
in our first table. This will of course make our averages for 
Columns VII and VIII the same as in the first table. We then 
compute* output totals for Column IV by multiplying the B 
average of each combination by 20. We then compute propor- 
tional and actual increases, beginning at the bottom, for Columns 



*Th- first table w^s constructed symmetrically in respect to A and B; So 
that, in making the second table, literal computation is unnecessary. 

104 



CHAPTER IV. COMBINING PROPORTIONS. 

V and VI. Finally, the marginal products for A's are computed 
from the bottom upwards and entered in Column IX. 

TABLE II. 
I II III IV V* VI* VII VIII IX* 



1^ 






O 








5^ 


Marginal 
Product 
of A's. 


1 


200 


20 


20 


20 


_ 20 


1 


.1 


— .3 


2 


133 


20 


40 


106 


— 40 


2 


.3 


— 1 


3 


100 


20 


80 


35 


— 60 


4 


.8 


—3 


4 


80 


20 


140 


56 


—140 


7 


1.7 


—6 


5 


66 


20 


280 


60 


_ 80 


14 


4.2 


—8 


6 


57 


20 


360 


56 


— 33 


18 


6.3 


—4 


7 


50 


20 


390 


50 


— 5 


19.5 


7.8 


— 1 


8 


44 


20 


397 


44 


_ 2 


19.8 


8.9 


- .5 


9 


40 


20 


400 


79 


7 


20 


10 


1 


10 


33 


20 


393 


63 


13 


19.7 


11.8 


2.8 


11 


28 


20 


380 


58 


18 


19 


13.3 


5 


12 


25 


20 


362 


43 


15 


18.1 


14.5 


5.5 


13 


22 


20 


346 


36 


16 


17.3 


15.6 


8 


14 


20 


20 


330 


34 


18 


16.5 


16.5 


9 


15 


18 


20 


312 


36 


22 


15.6 


17.3 


11 


16 


16 


20 


290 


38 


24 


14.5 


18.1 


12 


17 


14 


20 


266 


39 


30 


13.3 


19. 


15 


18 


12 


20 


236 


40 


36 


11.8 


19.7 


18 


19 


10 


20 


200 


19.8 


21 


10 


20 


21 


20 


9 


20 


179 


19.5 


23 


8.9 


19.8 


23 


21 


8 


20 


156 


18 


30 


7.8 


19.5 


30 


22 


7 


20 


126 


14 


42 


6.3 


18 


42 


23 


6 


20 


84 


7 


49 


4.2 


14 


49 


24 


5 


20 


35 


4 


19 


1.7 


7 


19 


25 


4 


20 


16 


2 


10 


.8 


4 


10 


56 


3 


20 


6 


1 


4 


.3 


2 


4 


27 


2 


20 


2 






.1 


1 


1 


Reading 


this 1 


:able upwards, 


we obviously 


have an 


exact 


analog 


ue of 


Table 

ards. 


I, /. e., 


, we have a tabl 


e in w 


hich one 


of the 


*Read upw 





105 



PRINCIPLES OF ECONOMICS 

factors (B this time) remains constant whi'e the other, A, in- 
creases. The results are of course the same also. From Com- 
bination 27 up to 19, output increases more than proportionately 
to the increase of A; from 18 to 9, it increases less than pro- 
portionately ; from 8 to 1 it decreases. When averages are fol- 
lowed, also, the results are the same as in our first table. That 
is, from 27 back to 19, the average, measured in either factor, 
increases ; from 18 to 9, as measured in B, it increases, but, as 
measured in A, it diminishes ; from 8 to 1, it diminishes, meas- 
ured in either factor. It is thus evident that, if the combina- 
tions behave as supposed when A remains constant while B in- 
creases, they will necessarily behave in similar fashion when B 
remains constant whije A increases. In short, anything which 
we can affirm about A, in the first series, can be equally affirmed 
about B in the second ; while anything w^e can affirm about B in 
the first series can equally be affirmed about A in the second. 

It follows from what has just been said that every particular 
combination in Table I wherein A is constant and B increasing, 
appears in another guise in Table II, wherein B is constant and 
A increasing; and, in consequence, we have a new choice of 
w^ays for expressing some of the most important cases. If we 
wish to describe a given combination from the A standpoint, 
we can treat it as a combination in which A is the constant 
factor or as one in which A is the increasing factor. Thus, if 
we know that A, as the constant factor in an A-B series of 
combinations, has reached the point of maximum efficiency, — 
Combination 9, — we can express the fact in this way, or we caif 
say, instead, that A, as the increasing factor in a B-A combina- 
tion, has reached the point of minimum productivity ; — we couM 
not increase the proportion of A without diminishing the total, 
we have no opportunity to utilize any more of it. 

In the preceding discussion we have been concerned with 
imaginary results of imaginary changes in the combining pro- 
portions of imaginary factors. We must now ask whether these 
results correspond in a general way with those which we should 
meet in actual life. The answer is, of course, affirmative. If, 
for example, one were to take a ten-acre field devoted to raising- 
potatoes and in successive seasons spend in cultivating it, say, 
1 day's labor, then 5 days', then 10, then 40, then 80, and so on, 

106 



CHAPTER IV. COMBINING PROPORTIONS. 

he would doubtless meet results analogous to those presented in 
or tables. That is, during a few experiments, the product would 
increase and that more rapidly than the labor ; then, for a con- 
siderable number, the product would increase, but less rapidly; 
finally, product would diminish. Do these statements need dem- 
onstration? As to the existence of the third stage, there surely 
could be no doubt : it certainly is possible to put too much work 
on a given crop, to cultivate it too many times. Again, there 
can be no doubt as to the existence of the first stage. One day's 
hoeing put on a ten-acre lot during the whole season would 
probably not produce an appreciable result. Anyhow, 5 days 
put on the same lot would increase the crop much more than 
five times as much as did the one day of hoeing. P'urther, there 
can be no doubt that ten days' hoeing would increase the crop 
more than twice as much as the five days did. That is, a stage 
short or long during which product increases more rapidly than 
labor, is assured. The only question remaining, then, concerns 
the second stage. Conceivably, the stage of more than propor- 
tionate increase might continue till that of actual falling-ofT came 
on. Is there in fact a transitional one during which product 
still increases but does so less than proportionally? 

It seems easy to establish the affirmative by two considera- 
tions ; — it being assumed that the practices of actual farmers 
may be trusted to furnish a clue to the more general principles 
of industrial technique. First, everywhere we find under cultiva- 
tion lands inferior, as respects productivity, to the very best. 
From this it must be concluded that the cultivation of 
the best lands has anyhow passed through the first stage; 
since, otherwise, the farmers would work those best lands 
harder rather than put their labor on inferior lands. Secondly, 
we find everywhere that, when different grades of land are 
already under cultivation, and, so, liie best ^md, anyhow, has 
passed through the first stage, a rise in the price of products 
leads farmers to put more labor on those best lands, or, in 
ordinary language, to cultivate them more intensively; — a thing 
which they surely would not do if nothing were to be gained by 
it. It follows, then, that land-labor co;nbinations frec[uently are 
in the second stage, i. e., the stage of output increasable less than 
proportionately. Of course, then, that stage is a possible one 
for such combinations, 

107 



PRINCIPLES OF ECONOMICS 

From the preceding paragraph we learn that, if we keep the 
land -elements constant in land-labor combinations while increas- 
ing the labor element the combinations would show three stages : 
(l) product increasing more than proportionately to labor, (2) 
product increasing less than proportionately to labor, and (3) 
product decreasing. But, as was shown in our discussion of 
imaginary combinations, if the above is true of a series of ex- 
periments wherein land remains constant while labor increases, 
it is of necessity equally true of a ser-ies wherein labor remains 
constant while land increases. That is, if 1,000 days' labor per 
year were put, first on one acre, then on two, then -on three, and 
so on, the combinations would show three stages: (1) product 
increasing more than proportionately to land, (2) product in- 
creasing less than proportionately to land, and (3) product de- 
creasing. 

In the foregoing attempt to show that the results of our 
imiaginary combination correspond to actual experience, we have" 
considered only land-labor combinations. But there is little need 
of argument to convince any one that similar principles prevail, 
in some degree anyhow, in the case of land-capital combinations. 
Thus, if our experiment had been to try the effect in successive 
seasons of ever-increasing quantities of fertilizer, we shouM 
doubtless have met with results substantially the same as those 
heretofore presented. For the first few seasons, product would 
have increased more rapidly than the fertilizer consumed ; later, 
product would have increased less rapidly; finally, it would have 
declined. Perhaps the second stage would have been briefer 
than in the case of the land-labor combinations ; i. e., the advan- 
tage of increasing the fertilizer used would have been exhausted 
sooner than the advantage of increasing the cultivation. But the 
general course of results would have been the same. 

In the preceding discussion, we were considering the case of 
combinations between land, on the one hand, and labor or capital 
or both, on the other. But we hardly need say that, if we were 
to consider combinations wherein the place of land was taken by 
a producible instrument like an engine or a power plant, we 
should have similar phenomena. Thus, if we suppose a power 
plant planned to supply ordinarily 100 horse power, to be fed in 
successive experiments 200 pounds of coal, then 240, then 280, 

108 



CHAPTER IV. COMBINING PROPORTIONS. 

and so on, we should find our plant passing through the same 
three stages so often described. Still, again, if we were to take 
in place of land a pair of draft horses, and make a series of ex- 
periments to ascertain the relation of their work output to the 
food supplied them, increasing the amount of such food in each 
successive experiment, we should meet results exactly analogous 
to those already worked out in the other cases. In short, we 
may be sure that we have here a general law for the behavior 
of combining factors under all possible combining proportions. 
Since familiarity with the results of possible combinations is' 
needed for a clear comprehension of the whole matter, let us 
summarize this discussion in a formal principle. 

Principle. Supposing that the attempt be made in successive 
production periods to increase the output (product) from any 
instrument of production by increasing the expenditure of assist- 
ing factors in connection with said instrument from zero up- 
wards, then, as respects the ratio of output (product) to expendi- 
ture for assisting factors, said instrument will sooner or later be 
found in each of the following stages,^ vis.: 

(j) Output increasing more than proportionately (at in- 
creasing rate) ; 

(2) Output increasing less than proportionately (at dimin- 
ishing rate) ; 

(3) Output decreasing. 

Note : The output or product here had in mind is goods 
output, not mioney output. The problem in hand is primarily 
one of industrial technique, not of business fi,nance. We are not 
asking whether the producer will make smaller or larger profits 
by choosing one combination rather than another, but whether 
he will get a smaller or a larger physical product. There is no 
harm in expressing the varying expenditure in money; but the 
output or product must be in the shape of goods. 

The preceding discussion has brought out the different stages 
in which a productive combination of two factors would one 
time or another be found, provided all possible combining pro- 
portions were tried. As already remarked, this study of possi- 



*It is possible to contend that the transition points between (1) and (2), 
on the one hand, and (2) and (3), on the other, ought to be treated as stages. 
In that case, we should have, as our second and fourth, these: (2) Maximum 
output per unit of changing factor and (4) Maximum total output. 

109 



PRINCIPLES OF ECONOMICS 

hilities is needed for a clear comprehension of the whole matter. 
It is also needed to prepare the way for some special cases to be 
considered later. But we hardly need say that not all of the 
possibilities considered have practical significance. If, for ex- 
ample, our combining elements were land and labor,- the first 
and last of the three stages we have been considering could 
never be realized in industrial practice, save by accident or error. 
Thus, the last would be shut out, since no one would be foolish 
enough to continue to increase the amount of labor spent on a 
piece of ground after the output, whether measured in the land 
or in the labor, was diminishing. So, the first stage vv'ould be 
excluded, since any of its combinations would give a smaller 
return, whether measured in land or in labor, than the first 
maximum combination — number 9 in our original table ; — and 
any of these inferior combinations could be changed into the 
first maximum by simply letting some of the land lie idle. Ac- 
cordingly, under normal conditions, a piece of land would be 
worked in one or another of the combinations ranging fiom the 
labor maximum to the land maximum. 

But, again, in representing the practical combinations as 
ranging" from the labor maximum to the land maximum, we are 
still recognizing a wider range than the facts will usually war- 
rant. In the real world, the land is probably never cultivated to 
the point of maximum capacity or returns; while, on the other 
hand, in older countries, anyhow, most of it is probably culti- 
vated beyond the stage of maximum efficiency. Generally speak- 
ing, it would pay to hold back the cultivation of land at Com- 
bination 9 only when land could be had in unlimited amount 
without cost; so it would pay to drive the working of the land 
as far as Combination 19 only when labor could be had in un- 
limited amount without cost. Accordingly, the combinations in 
actual use are usually to be found among those which we have 
called inter-maxima, i. e., 10 to 18 in our original table /^ Put- 
ting this into formal shape, we have the following 

Principle. Barring accident and error, divisible factors as- 
sisted by divisible factors will normally be found in some of the 
combinations which range from that of maxinium efficiency to 



*I hardly need say that a table corresponding to the facts of land culture 
^o';]d be no such simple or symmetrical one as that which we have used. 

110 



CHAPTER IV. COMBINING PROPORTIONS. 

that of maximum returns, i. e., in the stage of diminishing re- 
turns or diminishing efficiency. 

To bring our discussion into closer accord with conventional 
methods of treating the matter before us, I will formally set 
forth what is an obvious corollary from the general principle 
laid down on page — , viz., the point that, if we try to increase 
indefinitely the product from any given instrument of production, 
said instrument will some time or other get into the stage of 
diminishing returns or diminishing efficiency. The following will 
answer as a formal statement : 

Principle. The Instrumental Law of Diminishing Returns. 

In the process of attempting to utilize more completely any 
productive instrument by increasing the amount of the assisting 
factors combined with it, in other words, by expending more 
upon it, there comes a stage during which output, though con- 
tinuing to increase, does so more slowly than the assisting factors 
are increased, — it being assumed that all other conditions are 
unchanged, there being no improvement in technical methods, no 
deterioration in the instrument, and so on. 

The foregoing principle has brought out the chief point in- 
volved from the standpoint of the constant factor. As we saw 
earlier, substantially the same point can also be expressed from 
the standpoint of the changing factor. As we most usually con- 
ceive the matter, the constant factor gives off a larger output but 
not one as much larger as is the expenditure of the changing 
factor. But, in one very important connection, we are following the 
changing factor and conceiving it as making smaller and smaller 
additions to output. From this viewpoint, we have the Instru- 
mental Law of Diminishing Productivity. 

Principle. The Instrumental Law of Diminishing Productivity. 

Under normal conditions, the marginal productivity of either 
factor in a divisible factor combination tends to vary inversely 
as its quantity. 

Thus far in our analysis we have assumed that our combin- 
ing factors, A and B, are divisible; — that we could cut down at 
will the amount of A or B — of land or labor — used. If we had 
20 A's and 8 B's — Combination 7 in or first table — we could 
choose the superior combination. No. 9, by simply throwing 
aside 4 of our A's. But this assumption, that any and every 

111 



PRINCIPLES OF ECONOMICS 

factor is perfectly divisible, is obviously too sweeping. Many 
things are; but many others are not. Thus, a furnace for heat- 
ing the house, a plant for supplying power, a draft animal, — none 
of these can be divided, and, so, with none of them can the 
amount used be arbitrarily cut down. Does this fact alter the 
principles governing these cases? No and yes. As respects 
possibilities, this new case is substantially the same as that which 
we have considered. A furnace, a power plant, a draft horse, 
over aganst the fuel or food necessary to get work from it, will 
show the same three stages and the same two turning points 
which we have already met. Thus, if we suppose ourselves to 
have control of a 100 horse-power power plant, consisting of a 
single unit, and to make with it a series of experiments by which 
the coal fed to the furnace should increase in successive experi- 
ments from 200 pounds to 640, there can be no doubt that we 
should have results substantially as represented in the following 
table.* Here the return per power plant and per pound of coal 
increases up to Combination 6; from there to Combination 12, 
the return per plant continues to increase but that per pound of 
coal declines; from 12 on, the return per plant or per pound of 
coal declines. 

TABLE III 

1 II III IV V VI VII 

No. of Amount Amount Output Proper- Actual Average 

Comhina- of Power Coal, horse tional In- per lb. 

tion Plant lbs. power Increase crease coal 

1 1 200 30 15 ' 

2 1 240 48 6 18 .2 

3 1 280 64 8 16 .228 

4 1 320 77 9.1 13 .242 

5 1 360 89 9.6 12 .248 



6 




400 


100 


9.9 


10 


.25 


7 




440 


108 


10 


8 


.245 


8 




480 


114 


9.8 


6 


.237 


9 




520 


118 


9.5 


4 


.226 


10 




560 


121 


9 


3 


.216 


11 




600 


123 


8.6 


2 


.2 


, 12 




640 


124 


8.2 


1 


.193 



13 


1 


680 


123 


7.7 


— 3 


.18 


14 


1 


720 


110 
112 


7.2 


— 18 


.154 



CHAPTER IV. COMBINING PROPORTIONS. 

We have seen that this case of an indivisible factor gives us 
the same three-stage principle which we had before, provided we 
are considering possibilities. When, however, we ask as to 
actual, practicable, combinations, the answer shows some note- 
worthy dififerences from the case of divisible factors. In the 
first place, the practical combinations are not limited to the 
second stage. Those of the third stage, indeed, are shut out: — 
no one will knowingly feed additional coal to a power plant 
after this begins to cause a diminution in the power supplied. 
But, while the third stage is excluded, the first is not. Third- 
stage combinations are shut out because a better alternative is 
always open ; — a producer can always withhold the excess of 
coal and make his total higher. At this point he would belter 
give the coal away than to feed it to his furnace. When, how- 
ever, we are considering first-stage combinations, I he case is 
different. Since a single-unit power plant is not divisible; it 
must be used as a whole or not at all. Consequent^, when the 
need falls off, when we want less than the maximum power per 
coal unit, we can not maintain the best combination. No. 6, by 
simply leaving a part of the plant unused. Instead, we have to 
run the whole outfit at a lower stage of efficiency.* It follows, 
then, that, in an entirely reasonable handling of indivisible 
instruments of production, they will be used in the first or ante- 
maxima stage, — the stage in which the total output is smaller 
than it might be from the same amount of capital, were it 
properly distributed between the instrument (the furnace) and 
the auxiliary factor (the coal). 

In the second place, indivisble factors, if also producible, 
work differently from divisible in another respect. While they 
occasionally have a wider range of combination, they normally 
have a smaller one than do divisible factors. Thus, a single- 
unit power plant, though indivisible, is also producible and so can 
be consciously adapted to produce most advantageously the par- 
ticular output which will normally be demanded from it. This 
means that Such a plant will normally be constructed of such a 
size that, in order to perform its task, it will be worked in a 



*This suggests one of the advantages of large-scale production. If we 
have a central plant providing for many needs, we can make it up of several 
units; so that, when the need falls off, we can leave some of these units 
unusftd. 

113 



PRINCIPLES OF ECONOMICS 

combination little if any beyond the one of maximum efficiency, 
that is, the one giving the largest average per unit of coal. 
This would coincide with the maximum-efficiency combination 
exactly but for the fact that the larger plant costs something 
more than the smaller and so the saving in coal is partly offset 
by increased interest charges. In any case, there will be just 
one combination in which an indivisible factor will normally be 
worked either the maximum-efficiency combination or 
one but littie beyond it; though, under exceptional circum- 
stances, we shall work it in the first or ante-maxima stage. It 
should be added that, under other exceptional conditions, we 
shall have to work it in combinations which come later than the 
normal one. If circumstances are such that we need to get out 
of a particular heating plant all we possibly can even though 
fuel is thereby used wastefully, we naturally drive the plant 
into the very last combination which shows any increase over 
its predecessors. To apply these various considerations to the 
case embodied in our table, a plant would normally be used in 
combination 6 or anyhow one not much beyond; but in times 
of exceptionally small demand it would be used in any from 
5 to 1, while in times of exceptionally great demand it would 
be used in 10 or 11. 

Principle. It is perfectly normal for indivisible factors the 
supply of zvhich can not he multiplied indeHnitely to be worked 
in either the increasing-returns or the diminishing -re turns stage. 

Principle. Indivisible producible factors "vill normally be 
worked in the combination of maximum efficiency or in one 
nearly approximating that, but will at times be used in some 
increasing returns or some later diminishing returns combina- 



Note : The point embodied in the principle just stated, that 
indivisible producible factors are normally used at or near the 
point of maximum efficiency, must not lead us to think that 
capital in general is being used in this stage. The combination 
of maximum efficiency for any element is the one in which that 
element appears in the largest proportion in which it can be 
ipresent without being in excess. But to say that capital in 
general has reached this stage is to say that there are no pos- 
sibilities left in the way of machines, roads, bridges, tunnels, 
etc., whereby our efficiency could be increased, — a statement 
which is obviously untrue. 

114 



CHAPTER IV. COMBINING PROPORTIONS. 

In beginning this study of combining proportions, we started 
with the case of simple or homogeneous combinations wherein 
the assisting factor plays just one role with respect to the con-; 
stant factor. Thus, we thought of all the labor used on a piece 
of land as devoted to cultivating it in the narrow sense, — stirring 
the soil — ; so we thought of all the capital used on the land aS' 
taking the form of fertilizer. Still more perfect cases of this 
sort would be furnished by the draft animal over against the 
food supplied to it or the furnace over against the coal fed to it.: 
But we hardly need say that the combinations of the real- 
world are not of this simple character. We do not put all the 
labor used on a piece of ground into cultivating it or all the 
capital into fertilizer. Instead, some of the labor used on the 
land is devoted to preparing the soil, some to seeding, some to 
cultivating, and so on ; while some of the capital is spent on 
tools, some on seed, some on fertilizer, some on machines, some 
on storage facilities, and so on. In short, in real life we have 
to deal with cases of complex combinations wherein the new 
supplies of the changing factor are largely set to performing 
nezv functions instead of just performing more fully the old 
ones. Now, when we study changing combinations from this 
point of view, how greatly do we need to modify the conclu- 
sions already reached, — the principles already laid down? 

In the first place, we of course still have the possibility of a 
stage of returns increasable at increasing rate ; since we could 
have this if there were only one function which the changing 
factor could perform. The only question, then, is whether the 
new condition tends to lengthen this first stage. In general, we 
may say that it would not tend to modify said stage at all ; since 
the various functions are of different degrees of importance and 
the more important ones will usually be performed first, so that 
a second function would naturally be taken up only when we' 
had passed through the first stage completely. To this, how- 
ever, an important exception must be made. It is always pos- 
sible that some very important function of a particular factor 
can be undertaken only when we have a very large amount of 
that factor available, e.g., a system of drainage for particularly 
productive swamp lands. Accordingly, a great increase in a 
particular factor, especially capital, may suddenly put a given 

115 



PRINCIPLES OF ECONOMICS 

tract of land into a condition of greatly increasing returns. This, 
however, is obviously something exceptional which merely tem- 
porarily changes the course of things. 

We have noted the effect of our new hypothesis on the in- 
creasing-returns stage. What is to be said as to that of dimin- 
ishing-returns ? Evidently enough the existence of additional 
functions for a particular factor checks, puts a brake on, the 
working of the diminishing-returns principle. Before we have 
gone far into the diminishing efficiency stage in respect to one 
function, other functions present themselves in the performance 
of which our labor and capital wid give larger returns than they 
would if devoted to the fuller performance of the first function. 
The general effect, obviously, is to prolong the diminishing 
efficiency stage, — diminish the rapidity of its downward grada- 
tion. But, while the new condition introduced into our hypoth- 
esis checks the tendency of efficiency to fall off, it surely can 
not destroy that tendency. There surely are not left unper- 
formed an indefinite number of functions having an importance 
equal to, or greater than, that of the functions already provided 
for. 

Illustrative Problems. 

1. "Land of the second grade will not be brought under 
cultivation till all of the first grade has been cultivated to the 
point of diminishing returns." 

Explain what is meant and why it is true. 

2. "Very many pieces of capital, e.g., a hoe, a reaper, are of 
such a nature that, reckoning by periods of any length (say a 
year), they simply have to be utilized in the ante-maxima stage." 

Explain what is meant and why it is true. 

3. "The point made under Problem 2 suggests an important 
argument for large-scale production." 

Explain. 

4.The following quotation which is taken from a contempo- 
raneous discussion of the law of diminishing returns, contains 
an implied application of that law which is quite unwarranted. 
Explain what that application is and show that it is unwar- 
ranted. 

"It might be supposed that, with the qualifications stated, the 
law of diminishing return in this simple form, as applied to a 
certain portion of land, is so palpably obvious, :o iixiomatic, 
that it could never have been overlooked. There is, however, 
probably no other economic law of the first importance which 
has so often been forgotten or miscalculated. Mill himself has 

IIG 



CHAPTER IV. COMBINING PROPORTIONS. 

bestowed extravagant praise on the ardour and perseverance of 
peasant proprietors, although it is certainly true that much of 
their labour is pushed far beyond the point of diminishing re- 
turn, and is, from the economic standpoint, wasted. * * * * Be- 
fore recent legislation gave the Scottish crofters security 
of tenure and fair rents, they applied labour to the production 
of corn, — in this case barley or oats, — which in most cases had 
passed the point of diminishing return in the very first step 
taken. * * « * jj^ Scotland, generally, the farmers are probably 
the most enterprising and most efficient in the world; but it too 
frequently happens that they themselves apply, and in some cases 
induce their landlords to apply, capital beyond this point of 
diminishing return." 

5. "It is quite impossible to believe that industry as a whole 
\s saturated with capital." 

Explain what is meant and why it is true. 

6. Try to show that capital as a whole certainly is not at 
the point of maximum efficiency or at that of maximum re- 
turns. 

7. Would a divisible factor ever be used in the post- 
maxima stage, e.g., the stage wherein the return to that factor 
was absolutely decreasing because of the excess of the other 
factor? 

8. In what condition as respects efficiency would you expect 
industrial plants to be in boom times? in the depressed times fol- 
lowing a panic? 

9. A certain boiler is evaporating 700 pounds of water per 
hour at a cost of 100 pounds of coal, while it could evaporate 
1,225 pounds of water at a cost of 150 pounds of coal. In what 
stage, as respects efficiency, is it being worked? Prove. 

10. A certain telephone plant takes care of 900 subscribers at 
a total cost per annum of $4,700. It could take care of 950 
subscribers at a cost of $4,850. In what stage of efficiency is it 
being worked? Prove. 

11. "Transportation is not in the stage of diminishing re- 
turns, else no other railroads would be built. If existing roads 
did not make profits, new ones would not appear." Student's 
report. Criticize. 

12. Two or three years ago the Bell Telephone Company 
put in an entirely new plant at Ann Arbor. In what stage, as 
respects returns, is that plant likely to be at the present time? 
Explain. 

13. "If there were no such thing as a law of diminishing 
returns, a man havmg a one-horse shop could become a million- 
aire in a few years by simply doubling his capital from year to 
J ear." Criticise. 

14. "The telephone plant is probably in the state of increas- 

117 



PRINCIPLES OF ECONOMICS 

mg returns : i.e., if they could get new subscribers, the cost of 
maintenance would not increase proportionally to the increased 
rents collected." Criticise. 

15. "If land always remained in the stage of increasing 
returns or that of constant returns, it could never have any 
value or bear any rent." Explain, 

16. Show that the law of diminishing returns applies to a 
piece of land used as a site for an office building. 

Section B. The Efficiency of Industries as Wholes in 
Relation to Size of Output. 

One of the most important applications of the general theory 
of Combining Proportions and Product respects the capacity of 
any particular quantity of any factor, say land, to increase its 
output, with the aid of an increasing quantum of auxiliary 
factors, in response to an increasing demand. We are trying 
to get more product out of a given farm, what success do we 
have? Now, this problem is important in itself, particularly 
to the owner of the farm. But there is another problem, de- 
pending largely for its solution on the solution of this first 
problem, which is of much greater importance to people gen- 
erally as distinguished from the owner of a particular farm. 
This second and more important problem asks, not what success 
shall we have if we try to get more product from a particular 
piece of ground, but rather what success shall we have if we try 
to get a larger product from some particular indiistiy — say 
wheat raising — taken as a whole. 

Note : This new problem does not, like the first one, require 
us to keep one of the factors, land, constant : — we may devote 
to the industry under consideration, not only more capital and 
labor, but also more land. It, therefore, seems so different a 
problem from that already considered as to make their study 
under the same topic scarcely legitimate. Anyhow, to make use 
in this connection of the same terminology as that hitherto em- 
ployed seems of very questionable propriety. To talk about a 
stage of diminishing returns for a combination in which one of 
the factors remains fixed in amount and then use the same 
expression for a whole industry in which all the factors may 
change in amount seems a very unscientific procedure. In 
respect to the propriety of considering the two problems to- 
gether, it is to be said that they are in fact very closely con- 
nected. Whether or not an industry as a whole is in the state 
of diminishing returns or in that of increasing returns depends, 
for one thing surely, on whether the particular factors em- 

118 



CHAPTER IV. COMBINING PROPORTIONS. 

ployed in that industry are in said state. In respect to the mat- 
ter of terminology, to make these very diverse uses of certain 
phrases is surely bad ; but it is too well established in usage 
to be thrown out at the present time. 

Taking up, now, the matter of possibilities for industries as 
wholes, and assuming general conditions to remain constant, we 
surely have results which, in form at least, are analogous to 
those already reached in our study of individual factors. Any 
industry, taken as a whole, if we were to try to get from it all 
quantities of output from a very small amount up, would be 
found at some time or other in each of the following condi- 
tions or stages: (1) output increasable at increasing rate or 
diminishing cost,* (2) output increasable at constant rate or 
constant cost, (3) output increasable at diminishing rate or 
increasing cost, (4) maximum output or maximum cost, and 
(5) output actually diminishing. This last of course would 
never be realized, just as in our former case, because it would 
be foolish to expend effort in diminishing rather than increas- 
ing product. The fourth stage would be merely a point as in 
our preceding case ; since there could be but one maximum out- 
put. The second stage, however, would not as in our original 
case be a mere turning point from increasing to diminishing 
returns. Conditions would be constantly occurring under which 
the quantity producible without any material change in cost 
would be so considerable that, during periods sufficiently long 
to make the matter of much practical importance, we should be 
getting the necessary increases in output with only a propor- 
tional increase in expenditure. 

The above paragraph has dogmatically asserted for every 
industry the existence of three different stages in which it 
might be found under a perfectly rational procedure. Let us 
take a moment to confirm this statement. In respect to the 
first stage, diminishing cost, we should expect its existence for 
two or three reasons. First, the moment we come to deal with 
industries as wholes, we strike the matter of possible increase in 
specialization. Thus, if the amount of product which we must 
get from an industry is large enough, we can carry very far 
geographical specialization, — raising potatoes or apples or water- 

*For the sake of convenience we will commonly employ the "cost" rather 
than the "returns" phrase. 

119 



PRINCIPLES OF ECONOMICS 

melons from the lands preeminently adapted for raising them; 
and this, of course, means more than proportionally increased 
returns for our expenditure and, therefore, diminishing costs, 
A second reason for this result is to be found in the fact that 
calling on a given industry for an enlarged output means that 
increasing resort may be had to large-scale methods. We can 
make more use of machinery, can have greater specialization 
within each plant, and so on. All this means diminishing costs. 

But, again, it surely can not be questioned that every in- 
dustry would sooner or later get into the diminishing returns 
or increasing cost stage. One fundamental factor of industry, 
land, is absolutely limited in amount. Every single piece of it 
is surely subject to the instrumental law of diminishing returns, 
and so, of course, the total is subject to that same law. It 
follows that, even if all the land were equally good for the 
purposes of a given industry and we could afford to put all of 
it to the service of that industry, there would surely come a 
time when increased expenditure was not followed by propor- 
tionally increased reward, — when increase in product meant 
more than proportional increase in cost. But we hardly need 
aay that not all lands are equally good for the uses of any 
particular industry. Whether because of location or of qual- 
ities which could be altered only at an impossible expenditure, 
they differ greatly in fitness for a given purpose. In conse- 
quence, land as such comes under the dominion of the law of 
diminishing returns (returns increasab!e at diminishing rate) 
much sooner than it would" under the former hypothesis. 

But, it may be asked, would not the considerations adduced 
above to show that we may have a condition of increasing re- 
turns prove that we might go on indefinitely without ever reach- 
ing the stage of diminishing returns. May not the advantages 
derivable from greater specialization or from an increased resort 
to large-scale methods forever save us from falling into that 
dread condition? The answer must surely be a negative one. 
There certainly is a limit to the advantages derivable from 
specialization and large-scale production. Every industry what- 
soever, if called upon to increase its output indefinitely, would 
ultimately pass into a stage of diminishing efficiency or increas- 
ing cost. 

120 



CHAPTER IV. COMBINING PROPORTIONS. 

But, not only would every industry under the conditions of 
our experiment, inevitably be at some time or other in the 
condition of diminishing cost and at another in that of increas- 
ing cost, in many cases anyhow, it would at some time or other 
be in the condition of substantially constant cost. This merely 
means that the transition from the condition of diminishing 
cost to that of increasing cost is not a mere point, but may 
extend over a considerable change in the volume of output. 
When we remember that, in this case of industries as wholes, we 
are at liberty to increase all the factors so long as more of the 
stock of each is available, the possibility of such a condition of 
constant cost seems plain enough. Land, of course, is the factor 
which is most likely to fail us. Yet it surely must be admitted 
that there are many pieces of ground of substantially the same 
grade of efficiency, counting location, fertility, etc.; and, until 
all of the best grade had been put to use, the particular industry 
involved would be getting out its product at unchanging cost, — 
supposing no change in technical conditions. But the case is 
still clearer with industries which do not need so large a propor- 
tion of land. Just because of this fact, the number of sites 
which are of substantially equal efficiency for the industry in 
question is in excess of the need, and, so, production can ex- 
pand without being checked by the scarcity of the only factor 
which is strictly limited. 

We have argued that any industry, taken as a whole, may 
be in any one of the three stages as respects the relation of 
cost to increasing output. It should be added that these stages 
may alternate with one another in any order. An industry may 
be at one time in the condition of constant cost, then in that 
of diminishing cost, then in that of constant cost again, then in 
that of diminishing cost, and so on. More particularly, for 
every change there will be a period of constant cost. If. the 
enlarged demand for copper causes marginal cost to rise to 20 
cents, and if, at this marginal cost, output can be expanded, let 
us suppose, to any figure between 700 millions pounds and 900 
millions ; then, for a period during which demand ranges no 
more widely than this, copper would be a constant-cost good. 

We have seen that any industry may be in any one of three 
conditions : diminishing-cost, constant-cost, and increasing cost. 
But we should naturally expect, and experience confirms the 

121. 



PRINCIPLES OF ECONOMICS 

expectation, that some industries would be preponderantly in 
the first stage, others in the second, still others in the third. 
Thus, it is the accepted opinion among authorities on railway 
transportation that this industry is preponderantly in the con- 
dition of diminishing cost or increasing returns. Again, there 
can be no doubt that a large number of common manufacturing 
industries are most of the time in a condition of constant cost. 
Finally, the so-called extractive industries, looked at in the 
long run anyhow, are commonly viewed as in the condition of 
increasing cost: if we insist on using considerably larger quan- 
tities of copper, silver, cotton, wheat, etc., we shall have to con- 
sent to incur a higher cost in acquiring them. These distinctions 
among commodities, as will appear in Chapter IX, furnish the 
classification of producible commodities commonly used in the 
study of normal value. 

Up to this point in our discussion of the effects on cost of 
attempts to increase the output of any industry, we have 
assumed in a general way the maintenance of conditions which, 
in respect to fundamentals, are static, unchanging. A particular 
industry is in the condition of increasing cost, it being assumed 
that methods remain constant, save in so far as these experience 
the changes natural to the changing scale of production. It is 
of course possible, and often probable, that the course of dis- 
covery and invention will make the production of refined petrol- 
eum cheaper next year than it is this year. In consequence, the 
cost of furnishing an output 500 millions gallons larger than 
the present one, may prove a smaller cost per unit than the 
cost now incurred. This, however, would not disprove the 
statement that the petroleum industry is in the condition of 
increasing cost. Such a statement in any field of study assumes 
static conditions. It is of course permissible for persons to 
insist on taking into account possible changes of a fundamental 
sort, whenever they make statements with respect to the cost 
conditions of an industry. But, in that case, the difference in 
the assumption set out from should be made clear. It is surely 
of no advantage to contradict with heat the statement of some 
other writer when you are understanding that statement in a 
sense quite different from the way in which he understands it. 
Assuming that both these methods of interpreting such affirma- 

122 



CHAPTER IV. COMBINING PROPORTIONS. 

tions are legitimate,* they ought to be distinguished as being, 
respectively, static and dynamic assertions with respect to the 
present condition of the industry in question. 

Summarizing the discussions of this section we have the 
following principles : 

Principle. Every industry, if called on in successive pro- 
duction periods to increase its output from some very small 
quantity to the largest possible, will afpear at some time or 
other in each of the following stages or conditions: (i) dimin- 
ishing cost, (2) constant cost, (3) increasing cost, and (4) max- 
imum output, — static conditions being assumed. 

Principle. At any particular time, some industry will 
normally be in the condition of diminishing cost, some in that 
of constant cost, some in that of increasing cost. 

Illustrative Problems. 

1. Argue for the reasonableness of the proposition that, if 
the marginal cost of producing copper should rise from, say, 20 
to 25 cents per pound, at the latter figure this industry would 
probably be for a time a constant cost industry. 

2. Give some reasons for believing that railway transporta- 
tion is likely to be much of the time in the condition of dimin- 
ishing cost (increasing returns). 

3. Telephone engineers are credited with the opinion that 
their industry is, broadly speaking, an increasing cost industry. 

Argue for and against this opinion. 

4. "Agriculture in Virginia is in the condition of dimin- 
ishing returns, as the land is worn out." 

Show that this misapprehends the meaning of the phrase 
diminishing returns. 

5. An industry like the making of surgical instruments is 
likely to be in what condition? Explain. 

6. 'The gas business in Ann Arbor is in the condition of 
increasing returns ; since fixtures and pipe could be put into 
many more houses with small additional expense proportionately 
to the returns gotten from the new patrons." — Student's Report. 
Show that the writer did not understand what is meant by the 
condition of increasing returns. 

7. "Silver, iron, wheat,^ meat, etc., without much doubt 
should be classed as increasing-cost products." 



*This assumption is of doubtful validity. The affirmation naturally 
means that the larger output will cost less per unit than the smaller. The 
dynamic inerpretation makes it mean that the future product will cost less 
than the present. 

123 



PRINCIPLES OF ECONOMICS 

(a) What does this mean? 

(b) Argue for the reasonableness of the statement. 

8. "The price of increasing cost goods tends to equal their 
marginal cost of production." 

(a) What do you suppose is meant by the phrase "mar- 
ginal cost of production"? 

(b) Show that the proposition laid down does not give a 
very definite idea of what the price of such goods will be next 
year, even if we know their marginal cost now. 

9. Suppose that, while competition in the industry is still 
maintained, the conditions of production for a particular type 
of wooden chair are such that, if fewer than 1,000 chairs a year 
are produced, the cost per chair will be about $3 ; that, if output 
is between 1,000 and 20,000, cost will be about $2; that if it is 
between 20,000 and 50,000, cost will be $1; if between 50,000 and 
500,000, 50 cents; if between '500,000 and 2 millions, SO cents; 
if between 2 millions and 3 millions, 40 cents; if between 3 and 
4 millions, 55 cents ; if between 4 and 5 millions, 75 cents ; if 
between 5 and 6 millions, $1.25 ; and so on. 

(a) Suppose that in the year 1906, 700,000 of these chairs 
are produced ; that by 1915 the output has increased to 1,300,000 ; 
that by 1925 the amount is 1,600,000; and that by 1940 it is 
1,800,000. To what class of goods would these chairs belong 
during the period 1906 to 1940, looked at as a whole? 

(b) Suppose that between 1950 and 2000 the output .should 
increase from from 2,300,000 to 6 millions. To what class of 
goods would these chairs belong during that 59 years, looked 
as at a whole? 

Section C. The Efficiency of Countries as Wholes in Rela- 
tion to Volume of Output. 

In the preceding section we applied our analysis of the 
general relations of Combining Proportions and Product to the 
problem of how industries as wholes behave when called on to 
increase their total output. We now come to the most im- 
portant problem of all, — how countries or communities as 
wholes respond to such a demand. At any given moment the 
United States has a particular outfit of natural resources, of 
capital, and of labor. What will be the effect of trying to in- 
crease the total product obtainable from this outfit by increas- 
ing the proportion of one of the factors, say capital or labor? 
This is sureiy a question of much significance to all of us, but 
more especially to the particular class of persons who are 
responsible for the particular factor which is increasing. This 
grows out of the principle, already noted (p 102) and 



CHAPTER IV. COMBINING PROPORTIONS. 

later to be explained, that, under the normal working of the 
laws of price, each contributor tends to get that return which 
expresses the significance of the marginal contribution of his 
class ; from which fact it follows that, if the increase in his 
class lowers its marginal product, he will get a smaller return. 
Accordingly, we now undertake to determine how changes in 
the total stock of any particular factor belonging to a partic- 
ular community affects its productive capacity in general. 

It is hardly necessary to say that the question before us 
is of much complexity. At first sight it seems natural to give 
that question a dynamic interpretation. We would seem to be 
most interested in what is actually going to happen in the real 
world, not in what would happen under theoretically static con- 
ditions. Doubtless this is true to some extent ; but generally 
speaking, our highest interest is still in the problem under static 
conditions. Even if we are fortunate enuogh to escape the nat- 
ural penalty of excessive population because of greater tech- 
nical efficiency, this does not excuse our folly. We should be 
still better off if population were smaller; since, by hypothesis, 
the lower cost of production has no connection with the in- 
crease of population, but results from discovery and invention. 
Accordingly, we ask ourselves the question whether communities 
as such, static conditions being assumed, show themselves sub- 
ject to the same laws of return already considered, exhibiting 
themselves in the several stages of increasing, constant, dimin- 
ishing, and maximum returns with which we are now familiar, 
and, if so, what variations from the results previously met with 
are here to be noted. 

To the general question whether countries or communities, 
considered as wholes, show, under static conditions, the same 
stages, as respects the relation of efficiency to changes in total 
output, there surely can be but one answer, — the affirmative one. 
In the first place, every country of any size is certain to be in 
the condition of increasing returns or increasing efficiency in 
the earlier stages of its development. This is not to say that 
any particular piece of ground will necessarily be employed in 
that condition ; as we said earlier, farmers would work the land 
actually at the point of maximum efficiency simply by keeping 

a portion of the land out of cultivation, spending their efforts on 

125 



PRINCIPLES OF ECONOMICS 

a smaller piece. But, in dealing with a country as a whole, the 
case is quite different. Here the element of organic combina- 
tion comes in. To get the most out of our outfit of land we 
have to treat it as a sort of manufacturing plant, an indivisible 
unit, having many parts coordinated into a functional whole. 
Thus, our natural store of the metals is to be found only in a 
few places ; only a small territory can be used for raising trop- 
ical and semi-tropical products ; and so on. It follows that the 
best use of the whole involves geographical specialization, 
which, like all specialization, is possible only with a large 
market, and this must depend on a large population. Further, 
some parts of our natural plant are bui.t on a very large scale 
and could not be utilized at all or could be utilized only in a very 
petty way, unless we had a large population. For example, we 
had from the first the basis of a magnificent system of water 
transportation in the great lake chain; but it is only as popu- 
lation has developed all through this region that we could 
begin to utilize this great outfit at all fully. The harbors of a 
country also illustrate this idea of an indivisible natural plant, 
which requires a great population and a great commerce to 
secure its utilization to the point of maximum efficiency. 

We have seen that any country taken as a whole is certain, 
in the days of its early deve'opment, to be in the condition of 
ante-maximum efficiency, increasing returns. It is no less 
certain that a country is likely to remain for a longer or shorter 
period in the condition of constant returns. After population 
and capital have developed to a point where the country is be- 
ing utilized at substantially its best, there are still unexhausted 
resources, possibilities, of the same general grade as those 
already used. The larger the country and the more diversified 
its natural resources, the greater are these possibilities. Further, 
some of the industries of a country continue to be in the condi- 
tion of increasing returns after the greater number have passed 
that stage. The actual condition would then be as resultant 
of counteracting forces and might easily be a condition of con- 
stant returns. 

Again, it can not be doubted that some time or other the 
country will be in the condition of diminishing returns — re- 
turns increasable but at a diminishing rate. It is of course 
possible that some industries would never in practice be pushed 

126 



CHAPTER IV. COMBINING PROPORTIONS. 

into this stage, since the major part of human effort would 
necessarily be spent on the great basal industries, — the industries 
which cater to the common, universal needs. But, in the case' 
of the basal industries anyhow, there would surely come a time 
when we could not increase product save at greater cost per 
unit. The considerations already brought out would doubt- 
less delay the coming of this condition ; but it would certainlji 
come at last. The advantages to be derived from larger scale 
and from a more perfect coordinating of social resources are 
surely exhaustible, though the time of their exhaustion may be 
more remote than is commonly supposed. 

Finally, it is surely conceivable, though the possibility is not 
likely to prove of great practical significance, that a time will 
come when output can no longer be increased at all. 

We have insisted that, broadly speaking, any country, taken 
as a whole, may be brought into any one of the four possible 
stages. We now must emphasize a point already more or less 
sharply brought out by implication ; vis., this, that the process 
of passing through all the stages is vastly slower in the case of a 
whole country than in the case of a single piece of ground. Any 
country, taken as a whole, may be undermanned, under-popu- 
lated for a long period. Increases in population may increase 
product more than proportionately or at least proportionately, 
for many years, even for centuries. In addition to the consid- 
erations bearing on this point which have already been brought 
forward, the following may be adduced. The industry of a 
whole nation is a complex of many different industries. Now, 
as already seen, industries do not pass into the diminishing 
stage with equal rapidity. Some industries almost never reach 
this stage. Taking a country as a whole, in respect to some 
part of its economic activity, it has probably reached the dimin- 
ishing returns stage; in respect to another part, it is in the 
constant returns stage ; and, in respect to another part, in the 
increasing returns stage. In so far as increase of population 
means undertaking to increase output from the second and third 
groups, a condition of diminishing returns is shut out at once ; 
it is only from the diminishing returns group of industries that a 
condition of diminishing returns for the country as a whole can 
be reached. Now, it is doubtless true that the new demand 
created by a general increase in population falls with rather 



PRINCIPLES OF ECONOMICS 

disproportionate weight on the extractive industries, especially 
stock raising and agriculture, and, therefore, on industries in 
'which the stage of diminishing returns is reached at an early 
date. Yet this can be overstated. Very important elements even 
in the extractive industries are those parts which are con- 
cerned with the transporting and exchange of products. But, 
as already explained, the transportation industries are believed 
to be most commonly in the state of increasing returns, and 
the exchange industries are usually in the condition of constant 
returns. 

We have seen that a country as a whole is naturally much 
slower in reaching the point of diminishing returns than any 
single piece of land in that country. It seems even more cer- 
tainly true that a country will remain almost indefinitely within 
this diminishing returns stage. That is, an industrious, thrifty, 
and ingenious people seem to' be able to increase almost in- 
definitely the density of population without reaching the point 
where returns altogether cease to expand. The new people have 
to content themselves with a lower and lower standard of liv- 
ing; but they add something to the total output, and, therefore, 
do not have to starve. 

In the foregoing discussion of the behavior of a country 
taken as a whole, we have assumed that the fundamental condi- 
tions of production are unchanged — a static order of things pre- 
vails. If, now, we admit the dynamic element, leaving the way 
open for changes in productive efficiency brought about by dis- 
covery and invention, we must emphasize still more strongly 
the point just made, that a country as a whole passes with very 
great slowness through the several stages, — especially the dimin- 
ishing returns stage. It has in fact always been recognized by 
economists that the principle of diminishing returns is liable to 
be offset at any time by improvements in method. The 100 
millions units of today may be less easily produced than the 
200 of tomorrow. This is not necessarily a real suspension of 
the true law of diminishing returns ; since that law means that 
the 200 millions of tomorrow will be produced with greater 
proportional difficulty than the 100 millions of tomorrow; — and 
this probably would continue to be true. But, while not a true 
suspension of our law, this fact of improving methods miti- 
gates great'y the harshness of the consequences of that law, and 

123 



CHAPTER IV. COMBINING PROPORTIONS. 

so is of much significance and advantage to society. The man 
who is attempting to predict the future economic condition of 
society must surely take account of these possible changes in 
the fundamental methods and processes of production. 

Principle, (o) Countries, taken as wholes, like individual 
industries, may be found in the condition of increasing returns 
or in that of constant returns or in that of diminishing returns 
or in that of maximum returns. 

(b) Countries, taken as wholes, are consequently subject to 
the so-called Law of Diminishing Returns; i. e., the time will 
come when efforts to increase total output can succeed only 
through more than proportionate increase in expenditure, 

(c) The stocks of the several productive factors belonging 
to any country are subject to the so-called Law of Diminishing 
Productivity; i. e., the time will come when the marginal pro- 
ductivity of any factor will vary inversely as its quantity. 

(d) Countries as wholes and their stocks of factors reach, 
and pass through, the diminishing returns or diminishing pro- 
ductivity stage more slowly than do individual factors or in- 
dustries. 

(e) The tendency of a country or any one of its factors to 
show diminishing returns or diminishing productivity can always 
be temporarily offset by discovery or invention. 

Illustrative Problems. 

1. "On the whole I am disposed to think that the United 
States is still undermanned." 

(a) Explain what is meant. 

(b) Argue for the correctness of the opinion given. 

2. "If laborers would accept low enough wages, it would, 
under normal conditions, be almost impossible for employment 
to fail." 

Argue for the correctness of the above statement. 

3. "All land is subject to the law of diminishing returns. 
Consequently, every increase in population means that the mar- 
gin of cultivation has to be pushed lower, that the food of the 
masses costs more than before, and so the amount of poverty 
ever increases." 

Objector, "Such talk is all nonsense. There is no law of 
diminishing returns. It costs less to raise a bushel of wheat 
now than it did a hundred years ago. The real trouble is that 
the existence of a right of private property in land causes an 
ever increasing share of the product of industry to go to land- 
lords in the shape of rent." 

129 



PRINCIPLES OF ECONOMICS 

(a) _ Explain the meaning of the clause: "the margin of 
cultivation has to be pushed lower." 

(b) Does the fact (supposing it to be a fact) that "it costs 
less to raise a bushel of wheat now than it did a hundred years 
ago" justify the sweeping statement that there is no law of 
diminishing returns? Explain. 

(c) Formulate a proposition which it would justify. 

(d) If there were no law of diminishing returns in some 
sense or other, could any of the product go to the landlord as 
rent ? Explain. 

(e) If the law of diminishing returns were not true even 
dynamically, could "an ever increasing share of the product of 
industry go to landlords"? Explain. 

4. "With all respect to the contrary opinions of some re- 
formers, it can not be doubted that with the great advance in 
productive efficiency, the economic lot of the masses of work- 
ingmen has decidedly injproved during the last fifty years." 

Argue for the proposition that, assuming the same advance in 
industrial technique, the lot of the masses would have been 
still better had their numbers increased much less. 

5.^ "I can not understand the stress laid by economists on 
the importance of checking the growth of population. Every 
person born into the world brings with him not only a need for 
goods but also the power to produce these goods." 

Show that this is not quite adequate. 

6. "If population keeps on increasing as at present, every 
year is going to make the feeding of the race more difficult." 

Show that the above conclusion does not necessarily follow 
from the law of diminishing returns, 

7. Mill says that the law of diminishing returns asserts, in 
effect, that the limit set to the productive capacity of a country 
is an elastic one. 

Argue for the propriety of this method of expression. 



130 



CHAPTER V. 

THE MECHANISM OF EXCHANGE. 

With the present chapter, we begin the study of that topic 
which forms much the most important part of Economics, i. e., 
Exchange. The first matter to be considered under this head is 
the Mechanism of Exchange, i. e., the instruments and processes 
through which exchanging is effected. This involves going into 
the study of industrial technique more fully than is contemplated 
in our general plan. But the difficulty of this technique in the 
case before us and the need for pretty full knowledge of it as a 
preparation for the study of the principles involved, make this 
seeming inconsistency necessary. 

Section A. Money Exchange. 

The most obvious and natural form of exchange is manifestly 
the direct exchanging of goods for each other, — barter, as it is 
called. Mr, A who has wood to spare and wants a harness, 
gets into communication with Mr. B who has a harness to spare 
and wants wood, and a mutual exchange is effected. But no 
argument is needed to convince any one that this method of 
effecting exchanges must, generally speaking, be highly incon- 
venient and altogether inadequate. The necessary coincidence 
between exchangers as respects the kinds and amounts of goods 
wanted and offered, is one which would be realized only in 
exceptional cases and even then would be discovered only after 
.considerable trouble. Quite likely there is no one who wants 
the goods offered by Mi". A and at the same time can supply 
the goods wanted by Mr. A. The only solution of the problem 
would often be a triangular arrangement, by which Mr. A dis- 
poses of his surplus to Mr. B and gets the equivalent desired 
from Mr. C. Doubtless it would be possible to work out such 
a solution by means of a complicated system of credit barter. 
But a simpler solution is the one actually in use which may be 
called mediated exchange; by which we mean exchange where 
in a third something comes in to act as a middle term between 

131 



PRINCIPLES OF ECONOMICS 

the two kinds of goods which Mr. A offers and wants respect- 
ively. This third something Mr. A gets from Mr. B in exchange 
for Ihis own wood, and in turn gives to Mr. C in exchange 
for the latter's harness. 

Doubtless the earliest form of mediated exchange was one 
in which the third factor or medium of exchange was some real 
use — commodity; i. e., some commodity which most people 
wanted for some use to which it could be put directly, as, for 
example, cattle, hides, lumps of salt, cubes of tea. But quite 
early people got in the way of more or less completely devoting 
some one thing to this office exclusively, — setting up some one 
thing as the regular, conventional, medium of exchange, which 
people would rarely put to any other use. Such a specialized 
medium of exchange is called money; and a system of exchange 
employing such a medium is money-exchange. 

The preceding discussion, in bringing out the nature of 
money-exchange, has also of necessity brought out the primary 
function of money, — to act as the official medium of exchange. 
A second function, which naturally attaches itself to the official 
medium of exchange and is in some connections almost as im- 
portant, is to act as the generally used measure of values, that 
is, the thing in which the values of goods are computed and 
expressed. 

Analysis of a Typical Monetary System. 
(See Reading X.) 

In the beginnings of money-exchange, the money used was 
little more than official ingots of one or more precious metals. 
But with the evolution of an elaborate commercial order, the 
primitive money has developed into a complicated system con- 
sisting of several different kinds of money each adapted to 
a special sort of work, but all embodying a common unit and 
based upon a common standard. 

The first thing to be noted in such a monetary system is the 
unit or principal denomination and the subordinate denomina- 
tions related to the unit as multiples or fractional parts thereof. 
In our system, the unit is a dollar; subordinate denominations 
are the cent, dime, half-eagle, eagle, and double eagle. In 
Great Britain, the unit is a pound or sovereign; in France, 
a franc; in Germany, a mark; in Russia, a rouble; and so on. 

132 



CHAPTER V. MECHANISM OF EXCHANGE. 

Next after the different denominations of a monetary sys- 
tem comes the standard, which is properly defined as that which 
fixes the value of the unit. In the United States, the ultimate 
standard is a lump of gold weighing 23.22 grains pure or 25.8 
grains when alloyed. Whatever value such a lump of gold has, 
the dollar also has. If the value of the lump goes up, so also 
does that of the dollar. The relation of the monetary standard 
to the system is closely analogous to that of the standard of 
liquid measure to that system. That is, just as 8.33 pounds of 
pure water determines what shall be the volume of a gallon 
measure, so 25.8 grains of gold determines what shall be the 
value of a dollar. 

The monetary stock — the actual money — consists of standard 
money and several subordinate moneys. Standard money is the 
kind which immediately fixes the value of the unit, and in terms 
of which other moneys are reckoned. In a typical modern sys- 
tem, its most distinctive marks are the legal prerogatives of free 
coinage and full tender for debts. The chief subordinate moneys 
are, in our system, legal tender treasury notes, bank notes, 
silver dollars and their certificates, and subsidiary coin — frac- 
tional silver, nickels, and coppers. 

The legal tender treasury notes are a quasi-standard money, 
i. e., they do more or less fully the work of standard money. 
Without them all institutions needing to keep reserves of money 
to pay demand obligations would have to keep standard money 
for this purpose. As it is, such reserves largely consist of these 
treasury notes (in England, Bank of England notes). 

Bank notes, silver dollars, silver certificates, and subsidiary 
coin constitute the major part of the ordinary circulating money, 
the money actually, directly, used in the conduct of business. 
Subsidiary coin has the following characteristics: (1) being 
made of metal different from that which is the standard, (2) 
being short in weight, (3) having its coinage limited, (4) hav- 
ing its legal tender limited, and (5) being redeemable. The 
first characteristic is necessary to secure convenience in size; 
the second, to keep this kind of coin from being melted; the 
third, to keep it at par; the fourth, to hinder it from displacing 
the standard and to shut out forcing excessive quantities of it 
on creditors ; and the fifth, to relieve the public of any excess, 
as also still further to insure the parity of this kind of money. 

133 



PRINCIPLES OF ECONOMICS 

The silver dollar is more or less of an anomaly in our sys- 
tem, having full legal tender but not being freely coined. In 
effect, it acts as a subsidiary coin of large denomination. 

Illustratve Problems. 

1. Illustrate with concrete examples the drawbacks of barter 
as a method of exchange. 

2. Illustrate the use of money as a measure of value in a 
case of barter. 

3. In primitive communities the media of exchange have 
usually been objects desired for direct use and also objects 
commonly produced in the community. Give some reason or 
reasons for each of these facts. 

4._ During the first part of our history as a nation, silver 
fractional coins had the prerogatives of standard money, i. e., 
were freely coined and had the status of full legal tender. But 
in 1853 Congress deemed it necessary to put this kind of money 
into the position of subsidiary coin. How do you explain the 
fact that Congress got around to this opinion at about that 
particular time? 

5. Between 1890 and 1896 it was a common practice to put 
into notes and. mortgages a clause providing for payment in gold 
coin of legal weight and fineness. Try to get the proper ex- 
planation of this fact. 

6. When I say that 12.9 grains of gold .9 fine is the mone- 
tary standard of the Philippines, what is meant? 

7. In the United States in the year 1868, when gold pay- 
ments on treasury notes were suspended so that a gold dollar 
was commonly worth from $1.20 to $1.40, one of the great 
political parties proposed to pay the national debt in these 
irredeemable treasury notes, — which proposal, however, was de- 
feated in the Federal election of that year. In discussing the 
matter, writers commonly speak as if the national creditors ob- 
jected to being paid in treasury notes rather than gold; whereas 
no one of them probably would have thought of asking for literal 
gold money. Explain in scientific language what was the pre- 
cise issue of the controversy. 

Section B. Credit Exchange. 

In the preceding discussion it has been assumed that, even 
under modern conditions, practically all exchange is money- 
exchange in the sense that money actually changes hands in 
every transaction. But of course the student is aware that 
this is not the case. Almost all payments outside our own place 
of residence are made by means of documents, usually orders 

134 



CHAPTER V. MECHANISM OF EXCHANGE. 

to pay money issued by the postoffice, by banks, or by express 
companies. Even within our own community, a large number 
of payments are effected by orders commonly called checks. If 
these orders were immediately presented for cash, the transaction 
would really be one in which money was actually used, only the 
payment would be effected through an agent rather than by the 
debtor himself. But commonly, as we all know, the person 
receiving the check, instead of getting cash with it, presents it 
for deposit, so that the transaction is consummated without any 
use of money, by a mere transfer of credit from the account 
of the payer to the account of the receiver. This brings up a 
modification of money exchange which is of great importance 
in most English-speaking countries and which might be called 
credit money exchange or, more shortly, credit exchange. 
1. Analysis of Credit-Exchange. 

The real nature of credit exchange can most easily be 
brought out by beginning with the case of credit exchange be- 
tween two persons only, — book credit, as it is commonly called. 
Where there is reciprocal buying between two persons at the 
same time, it is obviously needless for each to deliver the pay- 
ment money. The natural procedure, plainly, is to compute the 
balance of the mutual obligations and have that balance paid 
by the one against whom it falls. If the two traders can trust 
each other, it is plain that a similar procedure is possible in the 
case of mutual purchases made at different times; for each can 
sell to the other without getting his pay, or by receiving as pay 
the right to claim money later, and at some future time the 
reciprocal obligations or debts thus created can be cancelled as 
far as possible and only the balance actually paid, just in the 
case of simultaneous purchases. In this simple case, we have 
the essential feature of credit-exchange, i. e., bringing about in 
some way a reciprocity of debts so that a considerable cancella- 
tion is possible and only a balance has to be paid in actual 
money. 

In the case just used to bring out the nature of credit-ex- 
change, i. e., book-credit, we have reciprocal 'buying between two 
persons, where reciprocity, and so possible cancellation, are 
assured. But there are comparatively few cases of this sort. 
Most of the buying of any one of us is from a set of persons 

135 



PRINCIPLES OF ECONOMICS 

quite different from those to whom he sells. In this case, how- 
ever, a true reciprocity of debts exists between any one and all 
the rest taken together. If Mr. A. could in some way set what 
he owes everyone over against what everyone owes him, a prac- 
tically complete cancellation would be possible. This will prob- 
ably never be feasible. But the idea can be utilized within con- 
siderable limits. For example, it can be applied in the exchange 
relations of a man and his immediate neighbors. Mr. A may 
not sell anything to that particular one of his neighbors from 
whom he has bought something; but he will almost certainly 
sell to some of those neighbors. As an offset to the claims of 
them, taken as a whole, against him, he can almost certainly 
bring forward claims in his favor against them, taken as a 
whole. If, then, we can arrange in some way to have all or 
many of the debts of a man to his neighbors pooled, lumped to- 
gether, and all of their debts to him pooled, cancellation, and so 
a great saving in the money needed, can easily be brought about. 
One of the most effective ways of doing this is to make some 
single institution a sort of common debtor and creditor, which 
institution then keeps effecting settlements with each of its pa- 
trons as itself the representative of all the rest. An example of 
this particular case is furnished by one of the most important 
kinds of credit-exchange ; viz., check-exchange. 

In the simplest form of checkexchange, the persons interested 
are all depositors in a common institution called a bank, i. e., 
they keep their funds in that institution. Mr. A then pays for 
his purchases by giving to his creditors orders (checks) on the 
bank. On the other hand, Mr. A receives pay from his debtors 
in the shape of checks on the bank, which he in turn deposits. 
Thus, Mr. A's transactions with his neighbors give rise, not to 
money payments between himself and them, but to a set of 
debits to the bank, on the one side, and a set of credits by the 
bank on the other. Obviously, these debits and credits can be 
cancelled, as far as they are equal, and money payment needs 
to be made only for the balance. What is true in Mr. A's case 
is of course just as true in that of his neighbors, as respects their 
relation both to his transactions and to any others which may 
arise. Thus, by working through a common agent who acts as 
the universal debtor and creditor, each is able to set his claim 

136 



CHAPTER V. MECHANISM OF EXCHANGE. 

on all the rest over against his obligations to all the rest and so 
establish the reciprocity, and thus effect the cancellation, which 
make the essence of credit-exchange. 

In the preceding case we have supposed that Mr. A and his 
neighbors keep accounts with the same bank. But much more 
generally there are several banks in the one place and Mr. A has 
many transactions with the patrons of banks other than his own. 
At first sight, this seems to involve a return to cash exchange, 
since a check on one bank deposited with another will not be 
debited to the former bank for any length of time, but will be 
presented for cash within 24 hours anyhow. In fact, however, 
the bank which is debtor because of the supposed transaction 
will doubtless have come into possession of checks on the creditor 
bank which it can use to offset the claim against itself. Even if 
it has no claims against tPiat particular hank, it will certainly 
have some against some of the others ; and, as the banks will 
settle their mutual obligations on a pooling plan, these claims 
against other banks will do just as well as claims against its 
creditor in offsetting its debits. 

The last sentence brings us to another very important develop- 
ment of credit-exchange, viz., the clearing, the settlement of 
mutual obligations among a number of different banks. Here 
the same device which enables Mr. A. to settle his debits and 
credits with a minimum use of money, viz., fixing things so that 
he is paired off against all other persons at once, is applied to 
settle the mutual obligations of banks. In general, the plan is 
to set up a common agent, a clearing-house association, with 
which each bank settles, — that association becoming the creditor 
of each bank for all claims of all other banks against that bank 
and becoming its debtor for all its claims against all other banks. 
A balance is then struck and whichever proves to be debtor, the 
bank or the clearing-house, pays the balance. Naturally, the 
clearing-house settles first with the banks which prove to be 
debtors, and then uses the money thus obtained to settle with 
the creditor banks. 

The last two paragraphs have had to do with check credit- 
exchange. Another and much older form is inter-local credit- 
exchange, or what is called Exchange in the preeminent sense. 
This is the form of credit-exchange which is used to effect pay- 

137 



PRINCIPLES OF ECONOMICS 

ment between different cities and countries with a minimum use 
of money. Here we have the same old device : claims for and 
against different countries, debits and credits, get into common 
hands so that reciprocity is established and cancellation is made 
possible. In practice, certain institutions in each country, banks 
or exchange houses, buy up all the claims on other countries and 
also sell for the use of their patrons claims on those other 
countries. Thus, they become the common creditors and the com- 
mon debtors of the dealers of their country in its relations to 
other countries ; and the debit and credit relations which they 
maintain with other countries are maintained with institutions 
similar to themselves. It, therefore, becomes easy to set the 
debits of a country over against its credits, cancel these in so 
far as the}^ are equal, and effect a complete settlement by paying 
a small balance in money. 

2. Instruments of Credit-Exchange. 
A side of credit-exchange to which we must give a moment's 
attention has to do with the instruments of exchange, — the 
papers, documents, used in effecting credit-exchanges. Nearly 
all of these are orders for the payment of money, made by one 
person, called the drawer, upon another person called the drawee, 
in favor of a third person (usually), called the payee. Property 
in such orders is transfered from one person to another by 
indorsement, i. e., by writing across the back the name of the 
payee or present owner, with or without some specific directions 
as to payment. 

(1) The most familiar credit instrument is the bank check 
which has already been mentioned. It is an order for the pay- 
ment of money drazvn by a depositor on his bank. It is used 
chiefly at home, i. e., within the town where the drawee bank is 
located. 

(2) One of the most important instruments of interlocal 
exchange is the bank draft. This is an order for the payment 
of money drawn by one bank on a bank in another place, in 
favor of another party. A bank draft is used when the initiative 
is taken by the debtor. He buys the draft, mails it to his 
creditor, who gets cash or credit for it from his bank, which, if 
not itself the drawee bank, proceeds to collect from the latter. 

(3) A third class of exchange instruments are so-called 

138 



CHAPTER V. MECHANISM OF EXCHANGE. 

money orders, — postal or express orders. These are drawn by 
local agents of the institution issuing them upon the central 
office, are sold to the debtor, sent by him to his creditor, who 
collects from the agent of the issuing institution located in his 
town. 

(4) When the initiative in settling a transaction is taken by 
the seller or creditor, the instrument employed is most exactly 
named a bill of exchange, though this phrase is also often applied 
to international bank drafts. Such a bill of exchange, also called 
a commercial draft, is an order for the payment of money 
drazvn by a seller or creditor upon his debtor in favor of the 
drawer or his banker. (If in favor of himself, he endorses it 
over to his banker.) When this method of settlement is used 
the creditor turns the draft over to his banker and gets credit 
for the proceeds, whereupon the banker sets out to collect from 
the drawee through banking correspondents. 

3. The Rate of Exchange. 
Another matter of much importance in connection with credit- 
exchange is the rate of exchange, particularly the rate in 
foreign exchange. As we have just learned, money payments be- 
tween the people of different communities are effected through 
agents in each community who assume the position of common 
creditor and common debtor for that community. In other 
words, these persons buy up money claims on other communities 
from any persons having such claims to dispose of, and sell 
money claims on other communities to any persons who may 
need them to make payments in those other communities. Thus, 
there is developed a traffic in such money claims — a traffic in 
"exchange," as such money claims are commonly named. The 
price at which exchange sells — at least in the case of exchange 
between different countries — is called the rate of exchange. 
Stated more formally : the rate of exchange is the price in one 
country paid in the money of that country for the right to dis- 
pose of a unit of the money of some o'ther country in that other 
country, or at least in some country other than the one in which 
the purchase is made. Thus, if I wish to buy from my bank 
the right to have five pounds sterling paid on my behalf in 
London, and find myself obliged to pay for that right $4.87 per 
pound, I say that the rate of exchange on London is $4.87. 

139 



PRINCIPLES OF ECONOMICS 

In domestic exchange, i.e., exchange between different parts 
of the same country, the rate of exchange usually means the 
difference between the face value of an instrument of exchange 
and what is paid for it. Thus, if I say that the Chicago rate 
of erchange on New York is 15 cents premium per thousand, I 
mean that, in selling a claim for $1,000 on New York, a Chicago 
dealer would get his $1,000 and fifteen cents extra. 

In working out the price or rate of exchange, the market 
naturally starts with the natural value of the unit of the money 
wanted, as measured in the money with which it is bought — i.e., 
the value of the money wanted as it would be if there were no 
difference of place, if the buyer of English money bought it 
right in New York to be delivered in New York. If the two 
countries have the same standard, say gold, then the natural 
value of either money in terms of the other can be ascertained 
by a simple operation in division. Thus, one dollar contains 
23.23 grains of fine gold; and the English pound, 113 grains. 
The pound, therefore, is naturally worth in our money as many 
dollars as 23.22 is contained in 113, i.e., $4,866. This natural 
price of a foreign money unit, measured in terms of the home 
money, is technically known as the par of exchange. 

The rate of exchange varies above or below the par of ex- 
change according as the demand for exchange at par is in excess 
of the supply or vice versa. If we are selling great quantities of 
cotton, wheat, etc., to the people of Europe and buying compara- 
tively little from them, then claims on Europe will be abundant 
and, other things being equal, cheap. That is, those of us who 
have claims on Europe to sell will be obliged to sell them cheap, 
while those of us that need to buy such claims can get them 
cheap. On the other hand, if we are buying many goods from 
the people of Europe and selling them comparatively few, then 
claims on Europe will be scarce and, other things being equal, 
dear. That is, those of us who have claims on Europe to selJ 
can get high prices, while those who need to buy such claims 
will have to pay high prices. 

These variations of the rate of exchange above and below 
par are limited by the cost to exchange houses of transporting 
the money ieself from the one place to the other, — it being 
understood that cost includes a profit to the exchange dealer. 
The variations from par can not be greater than this, because 

140 



CHAPTER V. MECHANISM OF EXCHANGE. 

any wider range would give exceptional profit to the exchange 
dealers, which would stimulate their competition, and so re- 
duce the difference to this amount. In the case of London ex- 
change, the possible variation from par is commonly in the 
neighborhood of three cents, i.e., the rate ranges from about 
$4,835 to $4,895. 

4. The Commercial Bank. 
In the preceding discussion of credit-exchange it has been 
necessary to make repeated mention of banks, because of the 
large part in the conduct of credit-exchange which is played 
by these institutions. The particular type of bank here involved 
— the bank in the strict sense as understood by English and 
American writers — may be described, in general, as an insti- 
tution which acts as common treasurer or fiscal agent for such 
part of the general public as choose to patronize it. As such 
common treasurer, it cares for the money of its patrons, makes 
and receives payments on their behalf, makes advances of money 
to them, etc. Its functions, more formally enumerated, are as 
follows : 

(1) Receiving deposits of current funds — funds which the 
depositor expects to employ in his current business — active 
funds. (Commercial banks, to a greater or less extent, get 
deposits of idle funds ; but this is not their distinctive business. 
Such funds more naturally go to savings banks.) 

(2) Discount. Making short time money loans to patrons 
on the discount plan. 

(3) Check-exchange. Honoring the checks drawn by de- 
positors and accepting for credit or payment checks drawn in 
favor of depositors. 

(4) Exchange. Buying and selling rights to claim money in 
other places. 

In addition to these, the most characteristic functions of 
banks, banks also collect debts for their patrons in outside 
places. Still again, one or more banks in most countries make 
a business of issuing circulating notes. Finally, many banks do 
more or less business in the way of safety-deposit.- 

Illustrative Problems. 

1. Suppose that you send a check on the National Bank of 
Ann Arbor to the Newcomb-Endicott Company of Detroit to 

141 



PRINCIPLES OF ECONOMICS 

pay for some goods purchased; and suppose that when the 
check finally gets back to you it shows the following endorse- 
ments : (1) Pay to the Peninsular Savings Bank of Detroit, 
the Newcomb-Endicott Company. (2) Pay to the State Savings 
Bank of Ann Arbor, Peninsular Savings Bank of Detroit. (3) 
Paid through the Clearing House, State Savings Bank of Ann 
Arbor. Trace the course of this check from the endorsements. 

2. Henry T. Crouch of Erie buys $1,275 worth of wheat 
from T. C. Craig of Detroit. 

(a) Suppose settlement to be effected with a wheat bill of 
exchange (also called a sight draft) and write out the sub- 
stance of the bill which would be used. 

(b) Suppose settlement to be made with a check and write 
out a facsimile (in substance). 

(c) Suppose settlement to be made with a bank draft and 
write out a facsimile (in substance). 

3. Whichever method of settling the transaction involved in 
the last problem is used, the particular credit document employed 
will inevitably take quite a journey from bank to bank while it 
is being collected. 

(a) Describe an imaginary course which it would very 
likely take if it were a sight bill of exchange. 

(b) Same, if it were a check. 

(c) Same, if it were a bank draft. (Compare Problem 1.) 

4. We buy a good deal from Brazil, but sell her little. We 
sell a great deal to Great Britain, but buy from her much less. 
Can you imagine a way in which one of these trades furnishes 
a medium of exchange for the other? 

5. Oct. 1, 1907, the different banks of Ann Arbor brought 
to the clearing claims against each of the other banks as 
follows : 

No. 1 against No. 2 against No. 3 against 

No. 2 $2213.19 No. 1 $4284.78 No. 1 $4974.66 

No. 3 1865.09 No. 3 2172.45 No. 2 1607.79 

No. 4 2415.96 No. 4 3043.18 No. 4 1093.24 

No. 5 512.21 No. 5 655.8 7 No. 5 625.88 

Total $7006.45 Total $10156.28 Total $8301.57 

No. 4 against No. s against 

No. 1 $3078.73 No. 1 $332.15 
No. 2 1793.16 No. 2 377.17 
No. 3 973.73 No. 3 1515.46 
No. 5 4633.96 No. 4 181.56 

Total $10479.58 Total $2406.34 
Compute the balance for or against each bank. 

6. Supposing all the claims of the Ann Arbor banks on one 
another which appear in the last problem to have consisted of 

142 



CHAPTER V. MECHANISM OF EXCHANGE. 

checks which were used in the regular course of business trans- 
actions ; 

(a) What must have been the total volume, expressed in 
money, of the transactions thus effected? 

(b) How much actual cash was needed to effect these trans- 
actions ? 

(c) What per cent of the total volume of transactions did 
this cash amount to? 

(d) What is the significance of these facts? 

7. Not many years ago it was estimated that the per capita 
money circulation of England was about $11 while that of France 
was about $51 ; yet, as every one knows, there was at least as 
much business per capita carried on in England as in France. 
How could the difference in the amounts of circulating medium 
required be explained? 

8. Some writers represent the development of credit-ex- 
change as a return to barter. Show that this is not true — that 
credit-exchange is still mediated exchange, nay more, that it is 
money exchange. 

9. Suppose I wish to buy a bank draft for £200 on London. 
With London exchange at $4,855, what should I be able to 
get the draft for? 

10. A wheat exporter of New York draws a bill on his 
London customer for £1375. What should he be able to get for 
this bill with London exchange selling at $4.87? with London 
exchange at $4.84? 

11. Suppose that a New York importer can get 50 gross 
of Sheffield razors delivered in New York for 44 pence each 
(the duty included), and that he can sell them for 95 cents each. 
What would be his profit on such a transaction if the rate of 
exchange on London were $4.84? if the rate were $4.87? 

12. From the last two problems what principles can you 
deduce as to the effect which a high or low rate of exchange 
tends to have on exports? on imports? 

13. "The greater part of our circulating medium consists, 
not of money, but of deposit currency." Explain what is meant 
by deposit currency. 

14. Near what point would you expect the rate of exchange 
on Europe to be found in the fall of the year? 

15. "A matter very frequently overlooked by the public is 
that a large share of the bank deposits of a country like the 
United States grow out of loans and so do not add to the 
cash holdings of the banks." Explain how this is SO. 

16. When exchange on London is at $4,895 or thereabouts, it 
is said to be at the upper gold point; and when in the neighbor- 
hood of $4,835, it is said to be at the lower gold point. Why 
are these called gold points? 

143 



CHAPTER VI. 

SOME ELEMENTARY PROPOSITIONS WITH RESPECT 

TO MONEY. 

It is much too early in our study of economic principles to at- 
tempt anything resembling a thorough treatment of the theory 
of money. Nevertheless, it is important to set forth at the very 
outset of our work some propositions bearing on this topic 
which, though little more than truisms, are yet frequently over- 
looked by the public, with the result that fooJsh errors gain 
acceptance and lead to hurtful legislation. 

1. Money is simply one particular kind among many kinds 
of wealth. 

For a variety of reasons, we very naturally look on money 
as wealth par excellence. Thus, money, being the kind of 
wealth which will procure for us all other kinds, naturally pre- 
sents itself to us as the most efficient, and so the most de- 
sirable, form of wealth. For the same reason, it is readily 
conceived as the typical, representative, form of wealth, the 
one which stands for all others. Again, money being the con- 
ventional measure of value, we very naturally express wealth 
in terms in money. For example, we say that "Smith has in- 
herited a half million of dollars," meaning that he has in- 
herited wealth of various kinds valued at a half million dollars. 
But, while these facts make it natural for us to look on money 
as wealth par excellence, they surely do not justify us in con- 
ceiving money to be the only form of wealth. Nevertheless, 
in earlier centuries whole communities have seemed at least to 
entertain such an idea; and, even in our own day, a few people 
come dangerously close to taking the same position. It seems 
best, therefore, to give as our first proposition in the theory 
of money the correct dctrine on this matter. 

2. Money is simply one among many kinds of capital {capi' 
tal goods), i.e., products which are wanted, not for their own 
sokes, but for the sake of other things which we can get through 

144 



CHAPTER VL MONETARY TRUISMS. 

them; and, relatively, money forms a rather small portion of the 
total capital of the community. 

Money as an instrument which is employed by people to 
facilitate the exchange of goods, to accumulate stores of capital, 
to transfer values, etc., is of course capital, just as truly as are 
buildings, engines, machinery, etc. But there are many people 
whom this degree of recognition for money does not satisfy. 
Just as certain peculiarities about this institution mislead care- 
less persons into thinking of it as the only true wealth, so these, 
or other, peculiarities lead many persons to think and talk as if 
money were the only true capital. Perhaps the peculiarities 
which most strongly work for this result are the following: (l) 
the immediate form in which capital is accumulated is commonly 
money or bank credit, and (2) all forms of capital, like all forms 
of wealth in general, are computed, expressed, in terms of 
money; e.g., we say that Mr. Craig has $200,000' of capital in the 
milling business, meaning that he has buildings, a dam, races, 
machinery, etc., devoted to producing flour, which have a value 
measured in money of $200,000. 

That the second peculiarity named does not justify us in 
conceiving money to be the only true form of capital is too evi- 
dent to need argument, though it will be a long time before the 
business world rids itself of the notion that somehow the money 
which buys the buildings, machinery, etc., is the real capital 
rather than the buildings, etc., themselves. 

The other fact which tends to make people look on money as 
the only true form of capital — that it is the form in which most 
capital is accumulated — seems to make the error somewhat more 
plausible, since all (nearly all) capital is sometime or other in 
this embodiment. But, really, the case is no better than before. 
The money stage of capital is only a momentary one, — only 
a transition form. Still more, it is only the representative form 
of capital, the shadow or image not the substance. While the 
capitalist is accumulating stores of money or bank credit, other 
men are manufacturing lumber, engines, machines, etc., practi- 
cally, if not literally, to the order of our capitali^d; and these 
other things for which the capitalist, or some on who borrows 
his money, exchanges his store of money or bank credit, con- 
stitute in the main the real, final, form of capital. 

145 



PRINCIPLES OF ECONOMICS 

J. Money is simply one particular kind of useful instrument 
of which our stock should he large enough to do the money work 
needing to he done as well as we can afford to have it done, but 
of which we do not want more than enough any more than we. 
want more than enough of chairs, clothes, stoves, engines, or any 
other useful article. 

Every time we spend any of our resources producing chairs 
we have so much less resources for producing food, fuel, clothes, 
etc. If we are sensible, therefore, we will stop producing chairs 
just as soon as our need for chairs is satisfied as fully as we 
can afford to have it satisfied, in view of our need for food, 
clothes, etc. The case of money is no different. We want our 
need for money satisfied to the same degree as our other needs ; 
but we do not want, and can not afford, anything more than this. 

4. Broadly speaking, it is of the very nature of money to cir- 
culate (in person or hy proxy), that is, to pass from one person 
to another in purchase of goods or to be held awaiting the occa- 
sion for such use. 

This proposition when understood must present itself to our 
minds as a mere truism. But various widely accepted fallacies 
indicate that it is constantly overlooked. "Putting money into 
circulation" is, with very many minds, an action so advantageous 
to society that it covers a multitude of sins against the general 
welfare. Thus, a government may be wasting the substance of an 
industrious people, carrying on a foolish and costly war. When 
economists complain, some one promptly answers that it is good 
for trade because it "puts money in circulation." Of course, the 
answer is easy. The money would be in circulation anyhow. 
That is its business. If the government did not take it from 
the owners by taxation or borrowing, those owners would them- 
selves be spending it on the good things of life, or on engines, 
machinery, mills, and other forms of capital. 

5. Broadly speaking, it is of the very nature of money to 
remain money — not to he consumed in the sense of being finally 
absorbed into the life of any individual. It follows that the fact 
that the stock of money is unchanged proves nothing as to how 
the amount of wealth or capital is affected by particular lines of 
conduct. 

This, again, is a truism which needs only to be understood to 

146 



CHAPTER VI. MONETARY TRUISMS. 

be accepted and yet is constantly overlooked by many people. 
If we complain of the foolish squandering of a great capital by 
a worthless heir, people at once say : "I don't see that any harm 
is done. The money spent by the foolish heir is still here. It 
has only been transferred to better hands." Of course the 
money is here. Money is nothing but a counter, a check so to 
speak calling for goods, a shuttle of exchange flying back and 
forth, helping different producers to effect the exchanging of 
their goods. But, while the money is here just as it would have 
been anyhow, something else is not here that would have been, 
had the foolish son followed in the steps of his father. That 
something is productive goods, engines, cars, bridges, shops, — 
something which would continue for years to give off uses, and 
which could have been produced by the same labor which was 
expended in ministering to the young man's follies. Society as 
a whole is vastly poorer than it would have been, though the 
quantity of money is just the same. 

6. It is of the very nature of money to go hack and forth 
between communities, to move like a shuttle out and in; trade 
with the outside world does not of itself tend to take away our 
money. 

The world outside our city or country wants our money in 
exchange for their goods (assuming that they do really de- 
mand it), not to keep for eating or wearing or warming houses 
or any other use which involves retaining possession of it, but 
to send it hack to purchase our goods. 

Illustrative Problems. 

1. "P'oreign trade can add to the national wealth only when it 
brings in a money balance." 

(a) What is the principal thing to be gained by maintain- 
ing trade relations with the outside world? 

(b) When would it be of advantage to have our foreign 
trade bring in a money balance? 

2. "A nation is so much poorer by every dollar it sends- otit, 
just as an individual is so much poorer by every dollar he 
spends." Criticise both clauses. 

3. "Everything we buy abroad takes just so much money 
out of the country." 

Show that this can not be true whether it is meant that such 
buying abroad takes the money out immediately or only ulti- 
mately. 

147 



PRINCIPLES OF ECONOMICS 

4. Suppose that official reports from all the banks of a 
certain city show that, on an average, 93 per cent of the de- 
posits received during a certain day consisted of checks, only 7 
per cent being in the form of money. What important fact with 
respect to the conduct of business in that city would be thereby 
disclosed? 

5. "It is sometimes asked whether the raising of a govern- 
ment loan to cover ordinary expenditures really causes capital 
to be lost, since the coins received by the government remain in 
existence, — even remain in the country. This objection has no 
weight whatever." — Pierson's Principles of Economics. Show 
that the statement in italics is correct. 

6. "We pay 110 million dollars per annum for the carrying 
of products between this and foreign countries. Think of it. 
One hundred and ten million dollars in gold coin has gone out 
of the commerce of this country into the commerce of other 
countries. Can New York stand this?" — James G. Blaine in 
1881. 

(a) Is it likely that we permanently lost 110 million dollars 
in gold from our circulation because we hired foreigners to 
carry our goods? 

(b) Is it likely that we even temporarily parted with that 
much gold on that account? 

(c) Is it likely that as a nation we should have been richer if 
we had done this carrying of products for ourselves? 

7. "I don't see that society as a whole loses anything by the 
giving of a fireworks exhibition costing $1,000. Of course the 
people who pay for the fireworks are just so much out. But 
then the $1,000 goes to the other people who furnish the fire- 
works ; so that society as a whole comes out even." Criticise. 

8. Bills drawn against these heavy shipments (of cotton) 
flooded the foreign exchange market this week (Nov. 19, 1903), 
depressing it to the lowest level since Nov., 1900." 

■"According to popular ideas, what result ought to have fol- 
lowed the heavy shipments of cotton referred to? 

''9. "My numerous armies promote the circulation of money, 
and disburse impartially among the provinces the taxes paid by 
the people of the state." — Frederick the Great justifying his wars 
in a letter to D'Alembert. (Quoted from Bullock.) 

"Was there anything in the facts stated to offset the sacrifices 
undergone by the people in paying the taxes? 

10. "The summer boarders are a great blessing to our little 
village ; because they put into circulation a lot of money, which 
m^ans at least temporary prosperity." 

(VVhat must we understand this phrase, "put into circulation 
money" to mean, if we accept the above as anything like an ade- 

148 



CHAPTER VI. MONETARY TRUISMS. 

quate explanation of the prosperity brought by the summer 
boarders? 

11. "The individual can get rich only by selling more than he 
buys and saving the surplus in the form of money or bank- 
credit. So a country can increase its wealth only by exporting 
more than it imports, and taking the difference in money." 

Discuss both parts. 

12. 'T am not convinced of the soundness of the orthodox 
doctrine that a country can have all the money it wants and 
needs, just as it can have all the engines, machinery, etc., which 
it wants. Money is very different from other things. It would 
be easy to give a man all the food and clothes he wants; but, 
however much money you offered him, he would take it all 
gladly/; _ 

Criticise. 

13. From a Salt Lake supporter of the "Seeing America" 
movement : "We recognize that Americans are annually spend- 
ing $200,000,000 in foreign travel. That practically every dollar 
of this vast sum is lost to the home circulation can not be dis- 
puted." 

Criticise the last sentence. 



140 



CHAPTER VII. 

CERTAIN FUNDAMENTAL PRINCIPLES OF TRADE. 

The preceding chapter brought out certain elementary proposi- 
tions with respect to money which, though little more than tru- 
isms, are yet often overlooked and so need to be remarked upon. 
For trade or exchange in general, there are similar elementary 
propositions — perhaps a little more removed from the status of 
truisms though certainly simple enough — which are also con- 
-stantly overlooked and so deserve comment. The most funda- 
mental one of these has already been given on page 18 in the 
principle that the chief function of exchange is to make co- 
operation and specialization possible. We must now add two 
others scarcely less fundamental or important. 

Section I. Say's Law. 

The first of these principles has to do with the conditions 
which determine the total demand fur goods. Demand, as 
understood by the economist, means the quantity of any goods 
which buyers actually stand ready to take, as conditions are, 
including the existing price. Demand in this sense obviously 
implies the existence of desire on the part of buyers, coupled 
with power to buy, — control of some adequate equivalent to be 
exchanged for the thing purchased. Now, it is plain that every 
producer will naturally be anxious to see the demand for his 
particular product become as large as possible. In order to 
promote this desirable result, he probably tries to make his 
product particularly good, — anyhow expends much effort seek- 
ing to convince buyers of its goodness. But he is seldom 
content with this. He wishes to enlist the conscious support of 
his neighbors and fellow citizens acting in their personal 
capacity or through public legislation. For example, he tries to 
get the rich in the way of spending their money liberally, or he 
urges the government to raise money by taxation and undertake 
expensive improvements. But it is manifest that, in order to 
enlist the support of producers generally in any scheme which 

150 



CHAPTER VII. PRINCIPLES OF TRADE. 

a particular producer may propose for helping matters, he must 
be able to show that said scheme will be of advantage to others 
as well as to himself. The usual way of doing this is to argue 
that the proposed scheme will increase demand for goods in gen- 
eral. Hence there arise even under primitive trade conditions 
various doctrines as to how general demand — total demand — re 
determined. These doctrines are nearly all erroneous ; so that a 
presentation of sound principles is of much importance. 

Principle. Say's Law. The Ultimate Identity of Demand 
and Product. 

In the last analysis', the demand for goods produced for the 
market consists of goods produced for the market, i.e., the same 
goods are at once the demand for goods and the supply of 
goods; so that, if we can assume that producers have directed 
production in true accord with one another's wants, total de- 
mand must in the long run coincide with the total product or 
output of goods produced for the market. 

Proof : First Hypothesis — Trade takes the form of barter. 

(1) Demand cannot include anything outside of product — 
output; for no one can demand goods except by offering other 
goods in exchange, and such goods must have been produced. 

(2) Demand must include all of the goods produced for the 
market ; for such goods will surely be offered in exchange, else 
they would not have been produced, and, in being offered in 
exchange, they constitute each a demand for other goods. 

(3) But, if demand can not include anything outside of prod- 
ucts and must include all of these, then demand and products 
must coincide. 

Second Hypothesis — Trade carried on with money. 

Here demand is immediately determined by the amount of 

money controlled by buyers. But, obviously, buyers can get 

money only by producing it or by getting it in exchange for 

something else which has been produced. That is, in the last 
analysis, in money-exchange as in barter-exchange, the things 

really exchanged are products; so that the case of money-ex- 
change is, from our present point of view, substantially the same 
as that of barter-exchange, and therefore is covered under the 
preceding hypothesis. 

Notes: (1) The proviso which appears in the second clause 

of the principle, — "assuming that all producers direct their pro- 

151 



PRINCIPLES OF ECONOMICS 

Auction in true accord with one another's wants" — is necessary ; 
since, if any producer should find that the particular goods he 
wanted were not offered for sale, he might decide to leave the 
exchange operation half completed, — selling his goods for money 
or credit but not using that money or credit to buy other goods, 
(2) This last must not be understood to imply that exchange 
is never complete unless the money received for goods sold is 
in turn used to buy other goods. In a few cases, the money 
which the seller gets for his goods is the ultimate thing he 
wants. For example, he may wish to get gold to use in makmg 
jewelry and may choose to do this by melting coins ; or he may 
have a fad for collecting gold coin just as another man might 
collect old pictures ; and so on. 

Illustrative Problems. 

1. "The destruction of property has one compensation in 
that it increases the demand for commodities or services and so 
makes trade good." 

Explain the fallacy. (See Reading XII, C.) 

2. "George Rankin is of course a big fool to spend $400 
making a mill dam in a creek which is dried up every summer 
and never has enough water to run an ice cream freezer ; but 
he is doing one good thing, — he is making a whole lot more 
demand for labor and so a lot more employment for laborers." 

Explain fallacy. 

3. "There is just so much work to be done. The entrance of 
women and children into the field of labor must drive out an 
equal amount of adult male labor." 

Criticise. (There are no doubt objections of real weight to 
the extension of child and female labor; but this is not one of 
them.) 

'4. "The real cause of the present standstill in trade is the 
inequality of incomes. There can be no effective demand, be- 
cause those who have the money to buy have no unsatisfied 
wants, while those who have the wants have no power to buy." 

Criticise. 

'5. In a certain part of a recent novel, Mr. Blossom, a young 
p^ainter and decorator, is trying to induce Miss Cynthia to give 
him a job re-decorating her house, which is somewhat behind 
the times in this respect. The latter part of the conversation on 
the matter is as follows : 

" 'Live and let live' is a good enough motto for me." 
" 'Live and let live,' " repeated Miss Cynthia, thoughtfully. 
"What do you think that means?" 

"Why, it's plain enough," said Mr. Blossom, strongly. 
"You're living all right, ain't you? Got enough of everything 
and something to spare . . . ; but you've got to let other 

152 



CHAPTER VII. PRINCIPLES OF TRADE. 

folks live. ... If there's anything you want done that you 
can't do for yourself, hire somebody that can do it . . . , 
so they can live, too. If everybody did that right along, I 
guess there wouldn't be so much talk about labor unions and 
strikes and all that sort of thing." 

(a) Would Miss Cynthia's deciding to spend and actually 
spending $600 to re-decorate her house increase the employment 
of laborers generally? 

(b) Why can we be certain that everybody is now doing the 
thing which Mr. Blossom thinks they ought to be doing? 

6. Street comment on a cold snap which bursts numerous 
w^ater-pipes : "Hard on householders, sure enough ; but no great 
loss without some small gain. It's a bonanza for Ann Arbor 
plumbers." Is that sound? 

7. Mr. A, having earned and saved $10,000, buries it in the 
ground. Another, having earned and saved $10,000, spends it 
on a great banquet. Which makes the greater demand for prod: 
ucts ? 

Explain. 

8. Would we naturally expect events like the San Francisco 
earthquake and fire to increase the demand for labor in general? 

Explain. 

9. "It is of course natural and, from the standpoint of cer- 
tain individuals immediately interested, desirable that the mem- 
bers of the Methodist Church or the Baptist Church or any 
other such like organization should give their custom to dealers 
who are members of their own organization. But, from the 
general economic standpoint, all such interference with the nat- 
ural course of things is highly undesirable." 

Give some reasons for this opinion. 

10. "Economically it is for the interest of every class of 
producers to see the efficiency of other classes of producers 
increase." 

Why? 

11. During the last fifteen years, the Western nations have 
laid much stress on making and keeping the Chinese trade open 
to all; and not a few have anticipated from the policy a great 
expansion in the market for our products. Show that Say's 
law suggests a reason for looking on such anticipations as rather 
ill-founded. 

12. "Every true friend of labor must condemn without re- 
serve all prison systems which devote convict labor to the pro-, 
duction of goods for the market. Every such system must,_ in 
the nature of the case, increase the supply of commodities with- 
out increasing the demand, and so must diminish the employ- 
ment available for honest laborers who keep out of prison." 

Show in detail (not by citing the principle) that the demand 

153 



PRINCIPLES OF ECONOMICS 

for goods is increased by convict labor as much as the supply. 

13. "The extraordinary advance in industrial technique 
characteristic of the last half century has so increased our pro- 
ductive capacity that, when things are running smoothly, output 
is bound, sooner or later, to exceed demand, which condition 
of things invariably leads to a commercial crisis followed by a 
general collapse of industry." 

Criticise. 

14. "The true way to insure industry against general over- 
production is to raise the rate of wages all along the line, thus 
increasing the buying power of the masses and therefore caus- 
ing consumption to overtake production." 

Criticise. 

15. The Chicago Record-Herald for April 18, 1908, contained 
the report of an interview with the head of one of America's 
great universities, wherein various opinions and statements were 
attributed to King Haakon of Norway, Among these was the 
following: "I could black my own boots if I wished to; I have 
done it and therefore know how ; but if I did, what would be- 
come of the people who make a living blacking boots?" 

Criticise on the basis of Say's law. 

Section II. The Principle of Reciprocity. 

If a man were told that he could get no good out of trade 
with his fellows unless he bought as well as sold, — that trade, 
as respects individuals anyhow, is necessarily reciprocal, — he 
would perhaps be quite impatient at being taken for a person 
so stupid as to need instruction in such truisms. But, when 
any question of trade between communities arises, this very 
same man will probably show himself quite oblivious to the 
principle which seems so evident in domestic trade. Thus, he 
will very likely consider it entirely possible, as well as highly 
desirable, to increase the volume of goods sold to other coun- 
tries while leaving stationary the quantity bought. Or he will 
bemoan the importation of goods from outside as decreasing 
demand for home goods, quite overlooking the fact that the 
goods imported must be paid for with others exported and there- 
fore must mean an increased outside demand for home goods. 
It is therefore necessary for us to set forth in quite definite and 
formal shape the almost self-evident truth that trade between 
communities, as well as between individuals, must be reciprocal. 

Principle. The Principle of Reciprocity. 

Exchange between communities, as between individuals, is 

154 



CHAPTER VII. PRINCIPLES OF TRADE. 

necessarily reciprocal; and, speaking broadly, the total of goods 
(not including money) sold by any community to all other com- 
munities must in the long run equal the total of goods (not in- 
cluding money) bought by that community from all others, save 
that there will usually tend to be a slight excess of goods ex- 
ports from communities not producing standard money metal 
and a more or less considerable excess of goods imports into a 
country producing standard nwney metal, — it being assumed 
that the distribution of population among diiferent communities 
remains substantially unchanged during the period under con- 
sideration. 

Comments: (1) The meaning of the principle is most easily 
brought out by application. In introducing the discussion, we 
inevitably suggested some of these. Thus, the principle is in- 
tended to tell us that no one can reasonably hope to increase the 
volume of goods sold by his community without also increasing 
the volume bought, and vice versa. So, it can not reasonably 
be charged that by buying goods outside we lower the demand 
for home goods and so the opportunities for employment at 
home ; for the goods bought outside must be paid for by goods 
produced at home, which means employment producing them. 
Again, it is not reasonable to fear that buying outside will cause 
an export of our money — unless we are producers of money 
metal ; for, supposing the quantity of money to be constant, 
goods exports and goods imports must tend to be equal. 

(2) The student should note that the Principle of Reci- 
procity does not tell us that the goods sold by the people of 
one country to the people of another country must equal the 
goods bought by the former from the latter. It only says that 
the goods sold to all countries must equal the goods bought from 
all countries. Taking our stand with any one nation, all its 
exports must equal all its imports, 

(3) The Principle of Reciprocity must not be understood as 
teaching that the exports of a country as reported by the cus- 
toms authorities must equal the imports as reported by the same 
authorities. In fact, these two sums are rarely if ever equal, 
though the total products sold — exports — must substantially al- 
ways be equal to the total products bought — imports. The ex- 
planation of this seeming paradox is easy. Customs reports do 
not, and can not, show all exports and imports. Thus, the 
true imports of a country obviously include everything bought 
by its people from the people of other countries. But some of 
these things bought from other countries can not, or at least do 
not, come to the knowledge of government officials. Of these 
the most important are (1) goods and services brought from the 
foreigner in his own country, e.g., by our people traveling there, 

155 



PRINCIPLES OF ECONOMICS 

and (2) services bought from the foreigner and delivered in our 
own country, but not appearing in import lists because as serif 
ices they do not go through the custom house. In short, there 
are invisible, as well as visible, imports ; and it is the sum of 
both of these which must be equal to the total of exports. What 
has been said of imports applies of course to exports. Of these 
seme are visible, some invisible; and it is their sum which must 
equal the total imports. 

Accordingly, if we wish to get a correct balance sheet of the 
exports and imports of a country ; we must add to the figures 
furnished us by the customs officials, figures from other sources 
— mostly mere estimates — taking into account these invisible 
exports and imports. Thus, if it is true, as some say, that we 
get transportation done for us by other nations to the value of 
$200,000,000 per year, we must enter on the import side of the 
balance sheet an item like this : 

Services of carriers $200,000,000 

So, if it is true that we use capital borrowed from other coun- 
tries to an amount which calls for $120,000,000 of interest per 
year, then we must enter on the import side this item : 

Services on Borrowed Capital $120,000,000 

or, in the more usual form: 

Interest on Borrowed Capital • • .$120,000,000 

I hardly need add that the countries selling us these services 
would have to make similar entries on the export side of their 
balance sheets. (See Reading XIV.) 

(4) It perhaps ought to be remarked that the Principle of 
Reciprocity above laid down should not be confused with the 
policy of reciprocity much advocated and occasionally practiced 
in this country. The latter, as indicated, is a policy in the con- 
duct of a nation's commercial relations, not a natural law govern- 
ing phenomena. Further, as a policy, reciprocity has its chief 
theoretic basis in alleged natural laws which are quite incon- 
sistent with the Principle of Reciprocity. Most advocates of the 
policy of reciprocity are more or less pronounced disbelievers in 
the Principle of Reciprocity. 

Argument for the Principle. 

A. The total exports — including money — must equal in value 
the total imports, assuming that no one is cheated. This is sure- 
ly self-evident. 

B. If we suppose that this necessary equality of exports and 
imports is not secured by the equality of goods exports and im- 

' ports affirmed in the principle, then it must be secured by a net 
! export or import of money. Now, the money involved in such 
".g: movement of money, say an export, might be (a) some part 
,'of a new output of money metal from a country producing such 

156 



CHAPTER VII. PRINCIPLES OF TRADE. 

metal, e.g., Australia or the United States, or (b) a portion of 
the stock of money already in use in the exporting country. But 
the first case is provided for in the principle before us. It only 
remains, then, to show that, in the long run, the equality of 
exports and imports, which is obviously necessary, will not be — 
can not be — secured by export or import from the existing money 
stock. If we increase our import of goods, we must, broadly 
speaking, increase our export of goods, not our export of 
money; and vice versa. 

(1) It seems almost justifiable to say that this statement is 
self-evident. A community could not for long pay for an ex- 
cess of imports by drawing on its stock of money ; since that 
stock would sooner or later become completely exhausted and so 
trade would have to cease. 

(2) But the objector would probably declare that this ex- 
haustion of the money stock is just what he fears, and its ap- 
pearance, together with the consequent cessation of trade, would 
decisively disprove the Reciprocity doctrine. It, therefore, is 
necessary to show that there is no danger of exhausting the 
money stock through trade or even of drawing it down to un- 
duly small proportions. 

(a) In the first place, under normal conditions, international 
trade is mediated through credit rather than through money, 
and, under the natural working of the principles of credit ex- 
change, goods exports and goods imports tend to be made equal 
automatically. The first part of this statement hardly needs 
comment. We have noted earlier that the exporter takes his 
pay in the shape of a credit on other countries and that these 
credits, getting into the hands of exchange dealers, are as far 
as possible cancelled and only balances paid in money. Such 
has always been the practice and, for manifest reasons of con- 
venience, always will be. The second part of the statement, if 
less familiar, is no less true. Under the natural working of 
credit exchange, exports and imports tend to be made equal 
automatically; the balances which have to be paid in money 
tend to disappear or to reach a neglible minimum. How this 
comes about is easily shown. 

As we have already seen, the medium of exchange in foreign 
trade is credit ; and, in the working of this system, foreign 
credit — exchange — is bought and sold and so has a price known 

157 



PRINCIPLES OF ECONOMICS 

as the rate of exchange. This price will be high in any given 
country if importing into that country is excessive and export- 
ing deficient, since this will make the demand for such exchange 
great and the supply small ; while, under the opposite conditions, 
the price of exchange will be low. But a high price for exchange 
will make exporting more, and importing less, profitable than 
usual, while a low price for exchange will make exporting less, 
and importing more, profitable than usual. That is, a high rate 
of exchange will stimulate exports and discourage imports, while 
a low rate will have an opposite effect. But it was excess of 
imports which caused a high exchange rate; hence excess of 
imports will tend automatically to increase exports and diminish 
imports. So, it was excess of exports which made the exchange 
rate low ; — hence excess of exports will tend automatically to 
increase imports and diminish expor<:s. And obviously these 
tendencies will persist in greater or less power until exports and 
imports become equal. So long as either buying from outsiders 
or selling to outsiders is in excess of the other, a rate of exchange 
is bound to obtain which discourages the side of trade which is 
in excess and stimulates its opposite, with the result that the ex- 
cess must progressively diminish and finally disappear. (See 
Reading XVI, B.) 

(b) The preceding argument has shown that international 
trade is normally carried on without the use of money and tends 
automatically to balance itself without the intervention of money. 
To lay finally the ghost that foreign trade will drain away our 
stock of money — to make clear that the necessary equality oi 
exports and imports can not, under normal conditions, be se- 
cured by exporting our stock of money but must be brought 
about through increasing the export of goods — to do this we 
need to show that any drain from the normal money stock of a 
country tends to be checked automatically. The demonstration 
is not difficult. 

In the first place, practically all the money which is exported 
from any country in the course of trade is taken from the bank 
reserves of the chief commercial and banking center, — in our 
case New York, in that of England London, and so on. The 
explanation of this strict localization of a money drain has al- 
ready been more or less fully anticipated. Trade with outside 

158 



CHAPTER VII. PRINCIPLES OF TRADE. 

people is, as we remember, almost entirely carried on with credit; 
and the international claims thus created get into the hands of a 
few exchange houses in the different countries, are as far as pos- 
sible cancelled, and the balances either way paid in money. But 
quite inevitably this dealing in, and settling of, international 
credits is mostly confined to the chief commercial center where 
the large volume of transactions develop the most efficient and 
least expensive processes of settlement. The exchange houses 
of this commercial center of course keep accounts with the 
banks of that center, or are themselves engaged in a regular 
banking business. In either case, the money which they send 
out will be taken from the banking reserves of the commercial 
center and, more especially, from that portion of the reserve 
known as the surplus reserve, i.e., the portion which is in excess 
of the amount which banks are by law required to keep; since 
this portion only is so free as to be fully available. 

It being recognized that a money export is inevitably taken 
from the banking reserve of the chief commercial and banking 
center, a long step has been taken toward our goal; for the 
banking reserve in question occupies a very significant place, and 
any considerable change in its volume is likely to bring about 
marked results. First, it is, in a very important sense, the re- 
serve, not only of the city where it is located, but also of the 
countr}^ at large ; for the banks of other cities keep from one- 
half to three-fifths of their reserve in the central city banks. 
Secondly, the reserve of the central city is, in the natural work- 
ing of things, kept down to the lowest possible amount, — in 
other words, the money funds of the center are kept employed 
to the limit of safety. This results from the large number and 
scale of transactions, the enormous amount of speculation, the 
stupendous projects which have to be financed — provided with 
ready mone}^ — at this center, and so on. This excessive utiliza- 
tion of the banking funds of the central city results in keeping 
down the surplus or free reserve to a very low point, say, from 
five to twenty millions. If business and speculation are very 
active, this surplus reserve is even likely to disappear altogether 
and be turned into a deficit. As a result of these peculiarities 
of the central city reserve, changes in its amount are of great 
significance, and are carefully, even anxiously, watched by the 

159 



PRINCIPLES OF ECONOMICS 

business community both of the central city and of the country 
at large. In particular, this central reserve has quite excep- 
tional significance in that changes in its volume quickly 
lead to opposite changes in the rate of discount, i.e., the rate 
of interest paid on bank loans ; — a change of a few millions in 
the bank reserve sometimes causing the rate on call loans to 
jump from two or three per cent to five or ten or fifteen. 

We are now prepared to show how a drain of money from 
the country tends to check itself. That result is accomplished 
through one or more of several series of reactions started by 
the outflow of money itself. The first series of reactions, and 
the one which works most promptly, is as ' follows : the outflow 
of money lowers the central city reserve to an abnormal point; 
this raises the rate of discount; the central city becomes a more 
than usually profitable place for the investment of capital; this 
leads foreign creditors to decide to leave their money capital 
here for investment rather than having it sent to them ; and 
so the outward movement of money tends to be checked. 

If this first series of reactions fails to accomplish the result, 
there are still a second and third to come in. The second runs 
as follows : the outflow lowers the central reserve ; this raises 
the rate of discount; a fall takes place in the price of securities 
and of the great staples — such as wheat, cotton, etc;* this fall 
in prices stimulates foreign buying of these securities and staples ; 
and such buying tends to turn the balance of international credit 
in our favor and so to stop the outflow of money or even to 
cause an inflow. 

In extreme cases, a still more powerful series of reactions 
may be set in operation. The outflow of money may go so far 
as to cause a serious deficiency of money for the purposes of 
general trade; this would tend to bring about a general fall of 
prices ; foreign buying of all sorts of export goods would be 
powerfully stimulated ; and the favorable balance of credit 
quickly resulting would surely stop any money outflow. 

Summarizing the discussion, it is plain that any considerable 
drain of the ordinary money stock of a country tends automat- 
ically to check itself; that, consequently, the necessary equality 
of exports and imports can not in the long run be secured by 
movements of money, save in so far as these are movements 

160 



CHAPTER VII. PRINCIPLES OF TRADE. 

of new stocks of money metal ; and, therefore, goods exports 
and goods imports must, broadly speaking, be equal. 

Illustrative Problems. 

1. "Another important reason for keeping our fleets as far 
as possible in our own ports is that under this policy the money 
they spend for ordinary supplies goes to our own people." 

Explain what the writer probably meant and criticise it. 

2. "A country gains by foreign trade only on condition that 
its imports exceed its exports — it gets more than it gives." 

The Principle of Reciprocity tells us that the above condition 
can not be fulfilled. However, one might admit that there is a 
sense in which imports must always exceed exports to make 
trade profitable. Explain. 

3. "When I came to Marblehead they had their houses built 
by country workmen, and their clothes made out of town, and 
supplied themselves with beef and pork from Boston, zvhich 
drained the town of its money." — Barnard's Autobiography. 

Criticise the part in italics. 

4. From a suppositious editorial of a Benton Harbor news- 
paper : "The annual influx of students and other outsiders into 
the fruit belt to engage in fruit picking and packing is an abuse 
which, should be stopped at once. These people consume verv 
little, saving their money to take back to Ann Arbor, Chicago, 
and the other places from which they came. Thus, while mak- 
ing large sums off us, they give little or nothing to the support 
of our industries." 

Criticise. 

5. "One reason for our almost constant excess of exports is 
that we are enterprising and so are always opening up new 
markets." 

Objector. "Opening up new markets might increase our exr 
ports but could not increase our excess of exports unless some- 
body cheated us, — seeing that our country is one of the chief 
producers of gold." 

(a) Argue for the correctness of the second quotation. 

(b) Why was the phrase from the dash, added? 

6. Remarks of a leading Congressman when it was an- 
nounced that the Canal Commission would purchase supplies 
wherever they could be secured most cheaply. "The President 
should be able to see the desirability of purchasing the supplies 
in this country alone, because thus employment would be given 
to American capital and labor instead of foreign." 

Explain fallacy. 

7. The chief reason for our excess of exports is to be found 

161 



PRINCIPLES OF ECONOMICS 

in the fact that the things which we sell are more necessary to 
our neighbors than the things which they sell are to us." 

Criticise. 

8. "The true way to quicken foreign demand (for British 
goods) was to open the ports to that foreign supply with which 
they paid us for what they bought from us." — Motley's Glad- 
stone, vol. 1, p. 267. 

Show that the above is sound doctrine. 

9. "If we buy rails from England, we get the rails of course, 
but they get our money; while, if we buy the rails at home, we 
have the rails and the money too." 

(a) Is there any reason to expect that our buying rails in 
England would carry off our regular stock of money? Explain. 

(b) Substitute "cotton" for "money" throughout the above 
quotation and show the fallaciousness of the doctrine. 

10. "The reason of high exchange is the buying much com- 
modities in any foreign country beyond the value of what that 
country takes of ours." — John Locke. 

Show that Locke's statement does not fully cover the case. 

11. "The trade of the United States shows an excess of ex- 
ports, because it is a large resourceful country which has to 
supply other countries with material." 

Criticise. 

13. "I have always believed that free trade would secure the 
greatest general prosperity, provided that all countries would 
practice it. But, if neighboring countries are bound to maintain 
protection, it is only fair to ourselves to do the same." 

(a) What is the real economic evil of having our neighbors 
^hut out our goods? 

(b) Would we better matters by shutting out theirs? 

13. A Detroit physician who has a son in the University at 
Ann Arbor requires the latter to buy his clothes and other sup- 
plies just as far as possible in Detroit, on the ground that, since 
his income is earned in that city, it ought to be spent there. 

(a) Has the father placed himeslf under obligations to the 
people of Detroit by earning an income from them? 

(b) Supposing the distribution of population unchanged, 
would Detroit as a whole get any more employment on the one 
plan than on the other? 

14. A* Western newspaper, anxious to hinder the people of 
the community from buying outside, represents a silver dollar 
as appealing to a home dentist about to send it to Montgomery 
Ward & Co. of Chicago, in the following strain : 

"Now, look here, Doc. If you'll only let me stay in this 
town I'll circulate around and do you lots of good. You buy 
a big beefsteak with me, and the butcher will buy groceries, and 
the grocer will buy dry goods, and the dry goods merchant will 

162 



CHAPTER VII. PRINCIPLES OF TRADE. 

pay his doctor bill with me, and the doctor will spend me with 
a farmer for oats to feed his buggy horse, and the farmer will 
buy fresh beef from the butcher, and the butcher will come 
around to you and get his tooth mended. In the long run, you 
see, I will be more useful to you here at home than if you 
send me away forever." 

(a) Clear up once more the fundamental errors in all talk 
of this kind. 

(b) Show that, even if we admit the principle implied in the 
quotation (that only the money spent at liome can complete the 
circuit so as to get back to the original spender), only a very 
small portion of the dollar could get back to the dentist. 

15. English people own much capital which is earning in- 
terest or dividends in other countries. What effect does this 
fact tend to have on England's exports or imports? 

16. "If it were possible for one county to provide by law 
or otherwise that no dollar which came into it could be sent 
out, within two years the county would be so much richer than 
its neighbors that they would begin to wonder, etc." — Western 
newspaper. 

(a) What do you suppose are his reasons for expecting 
such a policy to produce the great prosperity predicted? 

(b) Show that his great expectations are unreasonable. 

(c) Show that the policy in question would be likely to 
make the county poorer rather than richer. 

17. "You admit that it would increase the productive power 
of a given county to have a man with one hundred thousand 
dollars move in, bringing his money with him. How, then,, can 
you deny that the county would grow richer if it could and 
should for three or four years stop all money which came in 
from going out? 

Show that we are guilty of no inconsistency in admitting the 
one contention and denying the other. 

18. "Exports tend to stimulate imports, and vice versa^ 
Prove it. 

19. The following was taken from a country newspaper in 
1908 : "It appears to this paper that all this severe criticism 
. . . of Mrs. Howard Gould's requiring $70,000 a year to pay 
her expenses is quite uncalled for. What's the difference, any- 
way? If she and her folks have the 'dough,' let them spend 
it as fast as they like. That's better than hoarding it. When 
the money is spent it goes to some one and gets into circulation. 
We people whom circumstances compel to live on 30 cents a 
day would be glad to see all the old millionaires spending each 
$70,000 a year on himself, or ten times that amount if he wants 
to. The money isn't lost." 

(a) State clearly what advantage the writer of the above 

163 



PRINCIPLES OF ECONOMICS 

probably imagined that the public derive from the extravagance 
of Mrs. Gould and other rich people. 

(b) Explain the fallacy m the doctrine. 

(c) Show that the last sentence of the quotation is of no 
significance in the matter. 

20. "The so-called Principle of Reciprocity is all rubbish. It 
is child's play to show that we can sell to other countries even 
if we do not buy from those countries. No British buyer of 
American goods asks the question whether America buys British 
goods. His only question is : 'Does this article in character and 
price suit me?' if so, he buys it. Further, it is a matter of com- 
mon knowledge that a country will often buy a great deal 
from some other country, even though it sells little or nothing 
to that other country. Thus Germany has no better customer 
than England, whose goods she keeps out by tariff. So we buy 
largely from Brazil, though we sell her very little." 

(a) State the Principle of Reciprocity. 

(b) Show that the arguments against this principle con- 
tained in the above quotation have no bearing on the case. 

21. "Our neglect of the South xA.merican trade is simply 
scandalous. We buy a large amount from Brazil every year 
but sell her almost nothing, leaving her markets to be gobbled 
up by England and other European countries. We ought to 
subsidize a great merchant marine running to South America, 
and drive Europe out of a market which is naturally ours." 

Shov/ that a very plausible argument can be made for the 
contention that we should be cutting off our own noses if we 
were to drive Europe out of the markets of South America. 

22. Give one or more reasons why it may be desirab'e tc> 
patronize your home dealers rather than Montgomery Ward 
& Co., even though you consider the reasons usually given for 
such a policy quite fallacious. 

23. "For a long period Great Britain has imported more 
commodities than she has exported. This cannot continue in- 
definitely. One of these days she will be bankrupt." 

Is that sound? 

24. "One of the most serious objections to the Chinaman is 
that, even while he stays in this country, he consumes mostly 
commodities which must be imported from China ; so that his 
wages go to support, not American, but Chinese industries." 

Explain fallacy. 

25. "The one remaining chief foundation for national wealth 
is commerce. While individual wealth may be aquired through 
internal commerce, only foreign commerce can add to the na- 
tional wealth (a) ; and then only if the nation receives more 
than it gives (b). So the fact that there is a large and active 
commercial class in Japan does not necessarily imply the exist- 

164 



CHAPTER VII. PRINCIPLES OF TRADE. 

ence of a national asset. To the extent that a nation is compelled 
to purchase abroad articles necessary to its national existence 
in excess of articles produced in the country and exported to 
pay for them it loses commercially by the transaction (c). This 
difference, where it occurs, is usually called the balance of trade. 
Without attempting to discuss the economic principles involved, 
it suffices here to say that at present Japan's purely commercial 
activities do not constitute a national asset, for the balance of 
foreign trade is against the country. This condition has existed 
for twenty years now, and there is no prospect of a change. 
Consequently, Japan's foreign commerce must now be figured 
as a national liability." 

Criticise the clauses marked (a), (b), and (c). 

26. "To the same extent that the home market is wrested 
from foreigners and given to protected home producers, the for- 
eign market is wrested from unprotected home producers."— 
Seager, p. 381. 

Explain and defend the statement. 

*This grows out of the fact that there is a vast amount of speculative 
trading in these securities and staples and the further fact that this 
trading is largely based on borrowed capital. As a result, a high rate ol 
discount hinders people from buying as freely as otherwise and even 
drives them to sell their present holdings, — either of which procedure 
tends to lower prices. _ , . . 



165 



-; ' CHAPTER VIII. 

THE PRINCIPLES GOVERNING THE IMMEDIATE 
i. DETERMINATION OF PRICES. 

' ■ We have already more than once emphasized the point that, 
in the present economic order, exchange is the factor which 
4;ffects— makes possible — the co-operation of men in their eco- 
n'&mic efforts and, what is equally important, regulates, directs, 
that co-operation. It has also been noted that, in this regulat- 
ing of co-operation, the chief process whereby exchange ac- 
complishes the result is moving prices up or down. For ex- 
ample, if too little of any particular thing is produced, exchange 
presently gives us a higher price, which higher price makes the 
producing of the thing in question more profitable and so 
causes more to be produced. Again, exchange regulates the 
utilization of the stock already in existence through changes in 
price. Thus, if the stock of any commodity is exceptionally 
small, the price rises, people curtail their consumption, and 
thereby the abnormally small stock is made to go around. Fin- 
ally, exchange regulates how wealth shall be distributed, — how 
much each shall receive in wages, salary, interest, profits, 
etc., chiefly hy this same process of moving prices up or down. 
From these facts it is manifest that the processes of price de- 
termination are, in the present order, of paramount importance 
and that the natural laws which regulate these processes form 
a very vital part of the science of economics. 

For the present, we shall confine our attention to the prin- 
ciples supposed to be operative under complete freedom of com- 
petition and contract. Later we shall have to comment briefly 
on price making under monopoly, i.e., a state of things wherein 
the supplying of any commodity is practically under the con- 
trol of a single natural or legal person. Even in our present 
study it will need to be noted that competition and contract are 
in practice never completely free and so the principles now set 
forth are never perfectly operative. They do, however, play 



CHAPTER VIII. SUPPLY AND DEMAND. 

much the largest part in actual price determination and so niusit 
not be ignored. Vi.? 

In the present chapter, our especial task will be to bring oM 
the processes and principles by which the immediate determinz^ 
tion of price is effected. In other words, our first task may ht 
characterized as a study of the more superficial aspects of price 
determination. Still, again, our present study has to do with 
wholesale, rather than retail, prices. The latter are largely 
ignored in economic discussion. The principal reasons for this 
are: (1) it may be assumed that retail prices must tend to fol- 
low, and in the long run do follow wholesale prices, andr(2) 
the principles governing the variations from what wholesale 
prices would lead us to expect which actual retail prices show, 
are too complicated and obscure to reward adequately their 
serious study. .":: 

It is a fact with which almost every one has some acquaint- 
ance that, broadly speaking, the determination of price is some- 
how a matter of demand and supply. We naturally, then, begin 
with a study of these elements. The first point to be made is 
brought out in the following: •;, 

Principle. The Elasticity of Demand. 

Broadly speaking, the demand for any commodity which may 
be realised at any given moment varies inversely as* the price, 
though the rate of variation differs greatly for different goods. 

The principle is too familiar to need proof. Every one 
knows that a householder who is ready to buy one bushel of 
potatoes if 75 cents is asked, would probably take two if the 
price were lowered to 60 cents, would biiy four if 50 cents were 
the figure, and would put in his winter's stock if a price of 30 
cents were named. 

It follows from the principle just laid down that an adequate 
statement of possible demand at any moment must take the 
form of a schedule showing the amount which buyers stand 
ready to take at each one of a series of prices. Thus, we might 
suppose that in some country town where cordwood is brought 
in for sale every Saturday, the buyers on a particular Saturday 
put such an estimate on wood that, if the price proves to be $7, 
1 cord will be taken; if $6, 2 cords; if $5.50, 4 cords; if $5:25, 

*Remember that in Economics coincident variations are seldom, if ever, 
proportional. ;• 

167 



Demand 


Price 


mil. 02. 


cents 


. . 200 


59 


, 215 


58 


230 


57 


. 245 


56 


' 260 


55 


275 


54 


290 


53 


305 


52 



PRINCIPLES OF ECONOMICS 

7 cords; if $5, 10 cords; if $4.75, 17 cords; if $4.50, 25 cords; 
and so on. Such a series of possible prices and corresponding 
demands constitutes a demand schedule. A demand schedule is 
most easily handled in tabular form; so that the student will 
find it worth his while to put it into this shape. The following 
■section from an imaginary schedule for silver will illustrate 
our meaning. 

This signifies that the demand would be 
200 million ounces, if the price were 59 
cents ; 215 million ounces if the price were 
58 cents ; and so on. Obviously, the prices 
might be arranged to run up instead of 
down or the order of the two columns 
might be reversed without really changing 
the schedule. 

Notes : (1) Supposing the price of silver, 
when the above demand schedule obtains, 
to be 55 cents, then some persons are get- 
ting it at this price who would go without 
if the price went any higher. Such per- 
sons will be designated, in this course, marginal buyers, and 
the least utility which they get out of the commodity in ques- 
tion will be known as its marginal utility. This marginal util- 
ity might be characterized as social marginal utility in distinc- 
tion from individual marginal utility. The former involves a 
comparison of utilities to different individuals, while the latter 
compares utilities to the same individual. We use the phrase 
"marginal utility" in both senses ; usually the context will in- 
dicate which one. In interpreting social marginal utilities, we 
must remember that all comparison of the estimates of different 
individuals, whether estimates of utility or value or beauty or 
ii^randeur or any quality whatsoever is more or less misleading 
& that the same nominal measuring unit means different things 
[fo the different individuals. 

(2) In using schedules, the student must be careful not to 
interpolate other lines. Thus, he must not assume that, if price 
feill from 59 cents to 58^, demand would rise to, say, 210 
mil. oz. Very likely it would ; but, for convenience in handling 
br to bring out some point in theory, we have supposed the con- 
trary to be true, and this hypothesis the student is not at liberty 
to~ change. In general, the schedules are not intended to ex- 
press with nicety the facts of the market; but rather to illus- 
trate clearly and definitely the broad principles involved. 

'.,, ^ Illustrative Problems. 

1. Suppose that the conditions of demand for Milton's auto- 
graphs are such that 1 would be wanted if the price were $200; 
2 if price were $175; 4 if $150; 5 if $140; 8 if $125; 9 if $110; 

168 



CHAPTER VIII. SUPPLY AND DEMAND. 

12 if $100; 13 if $90; 15 if $75; and 20 if $50. Put this demand 
schedule into tabular form. 

(If the problem had said: 1 wanted at $200; 2 at $175; and 
so on, it would have meant the same thing.) 

2. Suppose that on the second Saturday of October a sec- 
tion of the demand schedule for wood in Ann Arbor is as fol- 
lows : 1 cord wanted at $7 ; 2 at $6 ; 4 at $5.50; 3 more at $5.25; 
3 more at $5 ; 7 more at $4.75 ; 8 more at $4.50 ; and so on. 
Put it into tabular form. 

3. The demand schedule of a certain rare brand of tea is 
as follows : 1,000 pounds wanted if the price is $1,000 per 
pound; 1,500 pounds if $900; 2,000 if $800; 2,800 if $700; 3,700 
if $600; 5,00€ if $500; 6,000 if $450; 7,000 if $400; 8,500 if 
$350; 10,000 if $300; 12,000 if $250; 15,000 if $200; 20,- 
OOO if $150; 40,000 if $100; 70,000 if $50; 120,000 if $25; 200,000 
if $10; 400,000 if $5; 800,000 if $2; 1,500,000 if $1; and 5,- 
000,0000 if $.50. Put it into tabular form. 

4. Suppose I say that the silver schedule used for illustra- 
tion above moves up two steps ; i.e., the demand becomes 230 
millions at 59 cents; 245 at 58 cents; 260 at 57 cents; and so on. 
Make out the new schedule in tabular form. 

5. Suppose that, after the price of silver had come down to 
55 cents, no further increase in demand took place even though 
price fell to 54 or 53 or 52 cents. 

(a) Make out a new schedule accordingly. 

(b) Supposing price under the new schedule to be 55' cents, 
what would marginal utility be? Prove. 

The preceding discussion was immediately concerned with 
demand. But no argument is needed to convince one that an 
analogous, though opposite, principle applies to supply. 

Principle. The Elasticity of Supply. 

Broadly speaking, the supply of any commodity which may 
be realised at any given moment varies directly as the price, — 
though the rate of variation diifers greatly for different goods. 

For this principle, as for the preceding one, proof is obvious- 
ly unnecessary. 

Again, it follows from this principle that the conditions of 
supply, like those of demand, need to be stated in the form of 
a schedule showing the amount which sellers are ready to ofifer 
at each of a series of prices. Thus, we may suppose the atti- 
tude of farmers who have wood to sell to be such on a particu- 
lar Saturday that, if the price were $7, 50 cords would be 
offered; if $6, 30 cords; if $5.50, 25 cords; if $5.25, 17 cords; 

if $5, 10 cords; if $4.75, 7 cords; if $4.50, 4 cords; and so on. 

169 



Demand 


Price 


Supply 


cords 


dollars 


cords 


1 


7.00 


50 


2 


6.00 


30 


4 


5.50 


25 


7 ^ 


5.25 


17 


10 


5.00 


10 


.. 17 


4.75 


7 


25 


4.50 


4 



PRINCIPLES OF ECONOMICS 

Such a supply schedule, like a demand schedule, is most con- 
veniently arranged in tabular form. Further, it is often con- 
Thus, the demand (Problem 2, page 169) and supply schedule? 
yenient in studying price problems to combine the demand and 
supply schedules in one table with a common price column, 
for wood on our hypothetical Saturday would make the follow 

i'ng table : 

Notes: (1) Supposing the 
price of wood under the above 
schedule to be $5, then some 
persons are selling wood who 
would refuse to do so if the 
price fell to $4.75. Such per- 
sons are known as marginal 
sellers. 

(2) It perhaps ought to be 
remarked that we can never 
have such exact knowledge of 
actual demand and supply con- 
ditions as the above schedules 
might suggest. These are all hypothetical; but they are of 
g-reat utility in enabling us to master the principles which gov- 
ern prices. 

Illustrative Problems. 

1. Suppose that in case of silver the conditions of supply 
are such that 290 millions ounces will be offered, if the price is 
59 cents; 275 millions, if the price is 58 cents; 260 millions, if 
57 cents; 245, if 56 cents; 230, if 55 cents; 215, if 54 cents; 200 
if 53 cents; 185, if 52 cents; and so on. 

(a) Make out this supply schedule in tabular form. 

(b) Make out a combined demand and supply schedule, us- 
ing the deman-d schedule on page 168. 

2. Suppose the supply schedule for wood on a certain Sat- 
urday to be as follows: 20 cords offered, if the price is $7; 
15 cords, if $6; 12 cords, if $5.50; 9 cords, if $5.25; 7 cords, if 
$5 ; 5 cords, if $4.75 ; and so on. Put it into tabular form. 

3. Suppose the supply conditions of a certain rare brand of 
tea to be such that 10,000 pounds will be offered, if the price is 
$.50 per pound; 11,000 pounds, if price is $1; $11,500, if $3; 
11,600, if $5; 11,650, if $10; 11,675, if $25; 11,680, if $50; 11,682, 
if $100; 11,683, if $150; 11,683.5, if $200; 11,683.8, if $250; 11,- 
683.85, if $300 ; and so on. Make out a combined demand and 
supply schedule for this tea, using the demand schedule from 
Problem 3, page 169. 

The facts just brought out with respect to demand and sup- 
ply might perhaps suggest to the student that we should natur- 

170 



CHAPTER VIII. SUPPLY AND DEMAND. 

ally expect to find each commodity having several prices. Thus, 

the demand schedule for silver on page shows 200 

millions ounces wanted if price is 59 cents, 15 millions more if 
price falls to 58 cents, and so on. That is, some persons want 
as much as 15 millions provided these can be had for 58 cents, 
though if price were 59 cents these persons would go without. 
In like manner, persons stand ready to take 15 millions more, 
provided, and only provided, price falls to 57 cents. And so 
on down the line. Again, a similar analysis of the supply sched- 
ule of silver, in Prob'.em 1 above, would show that supply 
breaks up into many parts just as demand does. That is, a 
certain quantity will be offered if price is 56 cents, 15 millions 
more provided, and only provided, price rises to 57 cents, 15 
millions more if price rises to 58 cents, and so on. Is it not 
natural, then, to expect that some silver will be sold at 59 cents, 
some at 58 cents, some at 57 cents, and so on? The answer is 
surely a negative one; and the reasons therefor are plain. There 
are doubtless buyers .on the market willing to give more than 
the price at which sales actually take place ; but the competition 
of sellers to gain the exceptional profit which such sales would 
secure, would make it unnecessary for any buyer to pay these 
higher prices. On the other hand, there are doubtless sellers on 
the market ready to furnish the goods at prices lower than the 
price at which sales actually take place ; but the competition of 
buyers to get the benefit of these lower prices would make it 
unnecessary for any seller to take such prices. Formulating the 
point thus brought out, we have the following 

Principle. The Law of Single Price. 

Broadly speaking, a commodity can have hut one price in the 
same market at the same time. 

Note : There are in actual life many exceptions to this, as 
to other, economic laws. The principle assumes perfectly free 
competition, full knowledge on the part of every one as to what 
is taking place, and so on. 

Corollary 1. The laws of single price secures to many con- 
sumers a different':al advantage known as consumer's surplus,, 
i.e., a quantity of other utilities which they can enjoy because of 
the fact that they can secure the one under consideration at a 
lower price than the price which they would he willing to give. 

Corollary 2. The law of single price secures to many pro- 
ducers a differential advantage known as producer's surplus. 

171 



PRINCIPLES OF ECONOMICS 

Illustrative Problem 

"On the Black Friday of 1869, gold was sold on one side of 
the room for $1.60 when it was being sold on the other for 
$1.35, etc."— Sumner. 

(a) Why is such a fact noteworthy from the economic point 
of view? 

(b) How was it to be explained, do you suppose? 

[, We are now prepared to see how price is immediately deter- 
mined under the working of what is commonly known as the 
Law of Supply and Demand. Let us begin with the table 
from page . . ., embodying the combined demand and sup- 
ply schedules of wood on a certain Saturday. A glance at 
this table shows that when the 
price is $5, demand and supply 
are equal ; and a very brief 
study shows that $5 must be 
the price which tends to be es- 
tablished. To prove this, we 
suppose the price to be some 
figure above or below $5 and 
easily show that such a price 
could not stand. Thus, sup- 
pose the figure to be $5.25. At 

this price, only 7 cords are wanted. But these 7 and even 3 
more, the sellers stand ready to furnish at $5; and, if only 7 
are bought, 3 cords will have to be taken home unsold, though 
ready to go at the lower price. Plainly, sellers will compete 
with each other to be the persons selling the 7 cords; and in 
doing this, will offer the wood at $5 per cord, thus bringing the 
price down to that figure. But, if the price cannot remain at 
$5.25, it still more certainly can not stop at $5.50 or $6 or any 
higher figure. It, therefore, can not be above $5. 

But it is equally easy to show that price can not be below $5. 
Thus, suppose that for a moment it drops to $4.75. At this figure, 
only 7 cords are suppled while 17 are wanted, and 10 of the 17 
are so much wanted that buyers are willing to give $5 rather 
than do without. Manifestly, the $5 buyers will push the price up 
to their figure, — it can not remain at $4.75. But if price can not 
be $4.75, it still more surely can not be $4.50 or any lower figure, 

172 



Demand 


Price 


Supply. 


cords 


dollars 


cords 


1 


7.00 


50 


2 


6.00 


30 


4 


5.50 


25 


7 


5.25 


17 


10 


5.00 


10 


17 


4.75 


7 


25 


4.50 


4 



CHAPTER VIII. SUPPLY AND DEMAND. 

i.e., it can not he helow $5. And, since it can not be either^bove 
or' below $5, it must be exactly $5. 

In the example just stated, the price which tended to be estab- 
lished is one at which supply and demand are exactly equal ; and 
this will usually be the case. But such exact equality is not 
necessary.* Thus, if we revert to the analysis just given, we see 
that price could not be $5.25, because supply at $5 was greater 
than demand at $5.25 ; while price could not be. $4.75, because 
demand at $5 was greater than supply at $4.75. That is, the 
quantities which we really have to compare are supply at the 
actual price with demand at the next higher price, and demand 
at the actual price with supply at the next lower. Fully stated, 
the really necessary condition is that supply at the actual price, 
if not as great as demand at that price, shall be greater than 
demand at the next higher price, and that demand at the actual 
price, if not as great as supply at that price, shall be as great as 
supply at the next lower price. This point is brought out in the 
two examples following, in each of which price will be $5, 
though in example A supply at that figure is less than demand, 
while in example B demand is less than supply. 





A 






B 




Demand 


Price 


Supply. 


Demand 


Price 


Supply 


cords 


dollars 


cords 


cords 


dollars 


cords 


4 


5.50 


25 


4 


5.50 


25 


7 


5.25 


17 


7 


5.25 


17 


10 


5.00 


9 


9 


5.00 


10 


17 


4.75 


7 


17 


4.75 


7 


25 


4.50 


4 


25 


4.50 


4 


In both these cases, price is 


more or less 


unstable. 


In A, it 



tends to rise temporarily to $5.25 to insure the getting of the 7 
cords which are valued at that figure. In B, it tends to fall 
temporarily to $4.75 to insure the sale of the 7 cords which are 
held at that figure. 

The preceding analysis has shown us that, given a certain 
demand schedule and a certain supply schedule, a price must be 
reached which insures the approximate equality of supply and 
demand. We need next to observe the effects on price of 
changes in demand or supply. Suppose, to illustrate, that, in the 
example above, demand at $5 advances from 10 to 15 cords. What 

*However, unless demand and supply are exactly equal, price is in a 
state of more or less unstable equilibrium. 

173 



PRINCIPLES OF ECONOMICS 

will happen to price? If this were really the only change, noth- 
ing would happen; for, as we have just seen, it is the relation 
of the demand at the next higher price to supply at the going 
price which determines the course of price. If that demand is not 
greater than this supply (the case of equality between them is 
one of unstable equilibrium), price will remain where it is. Thus, 
if the demand schedule read: 1 at $7, 2 at $6, 4 at $5.50, 7 at 
$5.35, 15 at $5, 17 at $4.75, and so on, price would still be $5; 
though demand at that figure had been advanced from 10 cords 
to 15. But, as a matter of fact, if demand at a particular price 
has advanced beyond what it formerly was at that figure, then it 
is practically certain that demand at each of the other prices in 
the schedule has advanced beyond what it was formerly. That 
is, we shall almost certainly have on hand a wholly new demand 
schedule. In this case, let us suppose it to run as follows: 3 
cords at $7, 5 at $6 ; 7 at $5.50, 10 at $5.25, 15 at $5, 20 at $4.75, 
30 at $4.50, and so on. If, now, we put this schedule in place 
of the demand schedule on page 172 we see at once that price 
must tend to be $5.25 instead of $5 as before. (Let the student 
work out the proof as in first example.) 

Let us now make a careful inspection of this new result in 
order to see what has happened. (1) First, price rose 
with the increase in demand, though only provided that, and 
because, the increase at the old price involved an increase at the 
higher ones also. (2) Secondly, the rise in price due to in- 
creased demand caused an increase in the supply and at the 
same time reacted to diminish the original increase in demand 
(under the operation of what principles?), — which processes ob- 
viously tended to restore the substantial equality of supply and 
demand and could not cease until that result had been reached. 
(Prove the last statement.) 

Now, let us return to our original schedule on page 172 and 
let us suppose that demand at the going price, $5, instead of 
increasing, diminishes. What will tend to be the effect on price? 
If the decrease is great enough to make demand at $5 .«5maller 
than supply at the next lower price, $4.75, price will fall* 

*If demand at some figure above $5, say $5.25, were as great as supply 
at $4.75, the price could not fall to the latter figure. But this is out of 
the question; since, if demand at $5 is smaller than supply at $4.75, de- 
mand at $5.25 or any higher figure surely will be. 

174 



CHAPTER VIII. SUPPLY AND DEMAND. 

Let us suppose the new demand schedule to run as follows : none 
wanted at $7 ; 1 wanted at $6 ; 2 wanted at $5.50; 4 at $5.25; 6 at 
$5; 10 at $4.75; 15 at $4.50; and so on. Putting this in place of 
the demand column of the schedule on page 172 we see at once 
that price must tend to rest at $4.75. 

Noting the particular results as before, we see: (1) that price 
fell with the decrease in demand, and (2) that this caused 
a decrease in supply and at the same time reacted to check the 
original decrease in demand, — which processes obviously tended 
to restore the equality of demand and supply and could not cease 
till that result was reached. It is thus evident that changes in 
demand tend to cause like changes in price. 

Turning, now, to supply, let us suppose this factor to in- 
crease, making the supply at $5, 25 cords instead of 10. Now, 
as before, if this change in supply indicates a change through- 
out the whole schedule, — as it doubtless does, — price must change 
in order to secure the necessary equality of supply and demand. 
Let us suppose the new supply schedule to be as follows : 100 
cords offered at $7 ; 75 cords at $6 ; 50 at $5.50 ; 30 at $5.25 ;• 25 at 
$5 ; 17 at $4.75 ; 10 at $4.50 ; and so on. Substituting this in the 
supply column of the schedule on page 172 we see that price 
must now tend to rest at $4.75, 

Analyzing the result as before, we see: (1) that price 
fell with the increase in supply, and (2) that this fall in price 
caused an increase in demand and at the same time reacted to 
diminish the original increase in supply, — which processes ob- 
viously tended to make supply and demand substantially equal 
and could not cease till that result was reached. 

Let us now reverse our last hypothesis by supposing supply 
to decrease, — giving us the following schedule: 25 cords offered 
at $7 ; 17 cords at $6 ; 10 at $5.50 ; 7 at $5.25 ; 4 at $5 ; and so on. 
Substituting this in the supply column on page 172 we see that 
price must tend to rest at $5.25. Analyzing this result, we see: 
(1) that price rose with the decrease in supply, and (2) that 
this rise in price caused a decrease in demand and at the same 
time reacted to diminish the original decrease in supply, — which 
processes obviously tended to restore the equality of supply and 
demand and could not cease till that result was reached. It is 
thus evident that changes in supply tend to be followed by 
opposite changes in price. 

175 



PRINCIPLES OF ECONOMICS 

Let us now summarize the results of this analysis in a formal 
statement. 

Principle. The Law of Supply and Demand. 

(a) The price-making forces can come to an equilibrium 
only at a price at ivhich supply and demand are substantially 
equal, — or, more precisely, a price at which supply, if not as 
great as demand, is anyhow greater than demand at the next 
higher price and at which demand, if not as great as supply, is 
anyhow as great as supply at the next lower price. 

(b) Supposing the price-making forces to be in equilibrium, 
any change in demand tends to be followed by a similar {not 
equal) change in price, which change in price tends to cause a 
similar change in supply and to diminish the original change in 
demand; which processes tend to restore the equality of supply 
and demand and can not cease till that result is reached. 

(c) Supposing the price-making forces to be in equilibrium, 
any change in supply tends to be followed by an opposite {not 
equal) change in price, which change in price tends to cause an 
opposite change in demand — i.e., a change in demand similar to 
the original change in supply,-^and to diminish the original 
change in supply; which processes tend to restore the equality 
of supply and demand and can not cease till that result is reached. 

Notes: (1) It is important to remember that neither supply 
nor demand has power directly to modify the other. An increase 
in demand is followed by an increase in supply only when it 
has raised price. So a falling off in demand is followed by a 
falling off in supply only when it has lowered price. 

(2) It is very important to note that, however deep we 
may go into the economic processes regulating price, we never 
escape the dominion of the law of supply and demand. It is 
doubtless always possible that a price, should be temporarily 
changed by the arbitrary, capricious, act of some seller. But 
this sort of thing is so exceptional as to be of little or no 
importance. Broadly speaking, prices will change only through 
the working of economic forces governed by natural laws. And 
these forces, whether proximate or remote, must do their work 
through the law. of supply and demand. That is, only in so far 
as any given force actually or potentially modifies either the 
demand schedule or the supply schedule is it able to change 
price. 

Illustrative Problems, 

1. "The price can not long remain above cost of produc- 
tion. For, so long as it is above, profits will be exceptionally 

no 



CHAPTER VIII. SUPPLY AND DEMAND. 

high ; this fact will cause production to increase ; as a result 

supply will become . . . . , and price will . . . ." 

Fill in the blanks, using the Law of Supply and Demand. 

2. -Take., the schedule for silver which you make out under 
Problem "l (a), page 171 and show what the price must tend 
to be. 

3. "Demand having increased, price rises. But this higher 
price cuts down demand ; and so price comes right back to where 
it was in the first place." 

Show that this result could not be reached in a normal case. 

4. "The demand for wheat was increased beyond the 
capacity of the best lands to furnish it, and so a new supply 
was brought out by 'putting inferior lands under cultivation." 

To make that reasoning quite complete, one or two other 
links should have been put in between the premise and the con- 
clusion. Supply those links. 

5. The table given below contains a section from a hypo- 
thetical supply schedule for silver and the corresponding sec- 
tions from five different demand schedules. 

(a) Interpret the supply schedule. (This is best done by 
beginning at the lowest prices.) 

(b) Show what the price would be with each of the dif- 
ferent demand schedules. 

(c) Notice that Schedule E gives us a very unstable case. 
Price tends to rest final'y at one point, but is liable at any time 
to be temporarily moved from that point. Explain (1) why 
price tends to rest where it does and (2) why its hold on that 
place is insecure. 

SUPPLY PRICE DEMAND. 

in in in 

mil. oz. cents mil. oz. 

SCH. A SCH. B SCH. C SCH. D SCH. E 

290 59 185 190 205 217 205 

290 58 190 203 218 230 218 

290 57 200 218 230 248 230 

260 56 209 230 245 260 245 

260 55 225 240 258 275 275 

198 54 230 255 270 290 290 

175 53 239 275 290 315 315 

175 52 246 290 310 330 330 

6. "The high rate of exchange makes exporting more than 
usually profitable. As a result, the supply of cotton for the 

foreign market the price ... ., this caused 

the foreign demand to .... , and so exports .... 
Fill out the blanks, applying the Law of Supply and Demand. 



177 



CHAPTER IX. 
NORMAL PRICE. 

In the preceding chapter, we confined our attention to the 
more superficial aspects of price determination — the processes 
and laws under which price is immediately determined. We 
must now go into the matter somewhat more thoroughly, asking 
ourselves : what are the deeper forces and processes by which 
price is determined? In "^o'mg this, we shall give our attention 
chiefly to what is called normal price or value. By normal 
price we mean the price ivh'ch tends to prevail throughout a 
given period, long or short, as determined by the forces which 
operate throughout the period and by those only. It is con- 
trasted with market price, by which is meant the price at 
which exchanges actually take place. Obviously, it was 
market price that we had in mmd wl^^n we were studying 
the immediate detci mmation ot prices ; and we often 
speak as if we had finished with market price when we 
have completed our study of the Law of Sujpply and Demand. 
It is plain, however, that, if market price is the actual price, 
then a deeper study of price is just as truly a study of market 
price as was the superficial one. Nevertheless, we are justified 
in confining our deeper study to the consideration of normal 
price; since, with respect to the deeper determination of market 
price, there is little of importance to be said outside of what is 
said about normal price — that is, the forces and laws regulating 
normal price are the most important of the forces and laws 
which ultimately determine market price. 

In Note (2) under the law of supply and demand, it was 
pointed out that practically all forces influencing price must act 
through the demand or the supply schedule. It follows that our 
natural procedure, in studying the more ultimate determination 
of price, is to begin with supply schedules and demand schedules, 
distinguishing the different kinds in so far as they have different 
effects on price, and ascertaining the deeper processes and 

178 



CHAPTER IX. NORMAL PRICE. 

forces by which those schedules are determined and of which 
they are an expression. 

Section A. Ultimate (Normal) Demand Schedules 

First, then, let us go into demand schedules a little more thor- 
oughly. The demand schedule which we have had in mind dur- 
ing most of our previous discussion is one which expresses the 
facts of demand at different possible prices for a given moment. 
But, in dealing with normal price, we are by definition dealing 
with a price which tends to be established during some period of 
time. In consequence, the sort of demand schedule with which 
we are now concerned is one which expresses the facts with 
respect to demand for such period of time. We shall want 
either a schedule showing total demand for the whole period 
studied or one giving the average total for the divisions of the 
period if it is more conveniently treated in this way. We might 
call such a schedule the ultimate demand schedule,* designating 
the one heretofore most commonly had in mind, the market 
demand schedule. It hardly need be said that the market sched- 
ule will be in large measure determined by the ultimate one, and 
so will be a more or less adequate expression of the latter. The 
two will not, however, exactly correspond ; for the market sched- 
ule will be influenced more or less by momentary forces, such as 
panic fear, over-sanguine hope, whim, etc. 

If, now; we try to g'et into the deeper meaning of the ultimate 
demand schedule, we first note that such a schedule is essentially 
the expression of the different valuations placed on the com- 
modity in question by would-be purchasers. That is, if we say 
that the ultimate demand schedule for Milton's autographs (see 
page 169) is; 1 wanted if price is $200; 2 if price is $175; 4 if 
$150 ; and so on, we also say by implication : 1 is valued by 
somebody at $200 ; 1 is valued by somebody else at $175 ; 2 are 
valued at $150 ; and so on. For it surely is obvious that in the 
long run the money price which buyers stand ready to offer for 
anything is an expression of the value which they put upon that 
thing. Accordingly, every ultimate demand schedule must be 
conceived as based upon, or embodying, a valuation schedule. 
Each of the prices in such a schedule is somebody's valuation of 
the commodity for some consumptional use. The valuation 

*In some connections, it is preferable to call this the normal demand 
schedule, and we shall oftm do so. 

179 



PRINCIPLES OF ECONOiMICS 

which is expressed in the price actually established is the mar- 
ginal valuation, and is the only one to which reference is often 
made. Those above it are supra-marginal valuations, while those 
below are suh-marginal. 

But the concept of a valuation schedule has taken us only 
one step below the ultimate demand schedule. We must go on 
to what lies beneath the valuation schedule. But this second 
step is as easily taken as the first. The valuation which a man 
ultimately puts upon a commodity must assuredly express more 
or less adequately his estimate of the capacity possessed by that 
commodity to satisfy his wants. In a word, behind the valuation 
schedule there is always a corresponding utility schedule; and, 
in fact, the same schedule may be interpreted indifferently as a 
valuation schedule or a utility schedule. Further, of course, on 
the basis of such a utility schedule the student can always con- 
struct an ultimate demand schedule. Thus, if I say that there 
are in Ann Arbor 10 sites of a certain grade substantially equiv- 
alent in efficiency and that there is one use for such sites which 
is worth $1,700 a year; 2 uses worth $1,500; 4 worth $1,200; 7 
worth $1,000; and so on; then this statement would be the 
utility schedule of such sites, and from it could be constructed 
the ultimate demand schedule as follows : 1 wanted at $1,700 ; 3 
at $1,500; 7 at $1,200; 14 at $1,000; and so on. 

The utility schedule, which, as we have just seen, underlies 
the valuation schedule, is plainly a composite made up from the 
utilities which the goods in question have for different persons. 
That is, behind what we might call the sociil utility schedule, 
there lie many individual utility schedules. From the stand- 
point of political economy, utility schedules, either social en 
individual, are the ultimate thing. We accept them from ex- 
perience without attempting any more final explanation of the 
forces determining them. 

We have just said that for us utility schedules are ultimate 
things. Now, one of the facts about such schedules which is 
most important in our study of price is known as the Law of 
Diminishing Utility. It may be expressed as follows : 

Principle. The Law of Diminishing Utility. 

The marginal utility of any economic good varies inversely 

as the quantity of it available. 

180 



CHAPTER IX. NORMAL PRICE. 

Comment: This principle is applicable both to the individual 
and to society as a whole; i. e., the phrase "marginal utility" 
can be interpreted as individual or social marginal utility. In 
either case, marginal utility means the utility of that portion of 
the stock or output or supply which is put to the least important 
use. 

Argument: (1) The uses to which any good may be put, 
whether by the same individual or by different individuals, differ 
in importance. (2) the different uses will be attended to in the 
order of their importance, beginning with the highest. Under 
these conditions, it is plain that, generally speaking, every in- 
crease in the quality available will cause some portion of the 
stock to be put to a lower use than heretofore provided for, — 
that is, will cause the marginal utility to decrease; while every 
decrease in the quantity will cause the least important use pre- 
viously cared for to be given up in order to save the stock for 
the higher uses,— that is, will cause the marginal utility to 
increase. 

Corollary. The marginal valuation of any economic good 
varies inversely as the quantity of it available. 

This is surely obvious. If valuations are expressions of 
utilities and marginal utilities vary inversely as the quantity, 
then marginal valuations must vary in like manner. 

This corollary, which might be called the Principle of Dimin- 
ishing Valuation, furnishes the chief explanation of the Law of 
the Elasticity of Demand, given on page 167. Thus, if we take 
the valuation schedule for Milton's autographs on page 179 : 1 
valued at $200'; 1 valued at $175; 2 at $150; and so on, it is 
plain that the first step in our demand schedule will be, 1 wanted 
at $200, but the second will be 2 wanted at $175, since at this 
price the second buyer will come in while the first will of course 
remain. So at $150, demand will become 4, /. e., it will include 
the two buyers at that price plus the two at $175, who of course 
remain. And so on. That is, demand will increase with falling 
price, or, more broadly, will vary inversely as price. 

Section B, Ultimate (Normal) Supply Schedules 

The preceding discussion has covered with sufficient fulness 
for our purposes ultimate demand schedules. We must now 
essay a similar task for ultimate or normal supply schedules. 

181 



PRINCIPLES OF ECONOMICS 

Here we find ourselves in the presence of quite different condi- 
tions. Market demand schedules and ultimate demand schedules 
are substantially alike in form and not greatly different in sub- 
stance. But market and ultimate supply schedules often differ in 
a marked degree. The former are practically all subject to the 
Law of the Elasticity of Supply laid down on page 169, i. e.^ 
supply varies directly as price. But ultimate supply schedules 
fail into two great classes, in one of which supply is literally or 
substantially fixed, unvarying, while in the other supply varies, 
though not necessarily in the usual way. The most typical 
case of a fixed-supply commodity is that of some good which is 
non-producible — man can not make it — and which is at the same 
time substantially indestructible — man can not destroy it or any- 
how, acting normally, will not. Among the most important 
goods of this class are the uses of land or land itself. Within 
the area of any city there are just so many sites of a particular 
grade. Broadly speaking, no human action can increase or dimin- 
ish their number. In the long run, they will all be offered for 
rent. In the long run, therefore, the supply at the best price 
which can be had will be the whole number existing, say 10. 
That is, owners will see that all the sites are rented (remember 
that there is supposed to be competition) even if they have to 
take $1 a year. Accordingly, a section of the ultimate supply 
schedule for these sites will run as follows : 10 offered at $2,000 ; 
10 offered at $1,900; 10 at $1,800; 10 at $1,700; 10 at $1,600; 10 
at $1,500; and so on. 

Another sort of non-producible commodity is something pro- 
duced by persons who are no longer living, e. g., pictures by 
Raphael, autographs of Milton, etc. The ultimate supply schedule 
of such a commodity would obviously be similar in form to the 
one just given; i. e., the supply figure would include the total 
stock and so would be the same for every price. 

But producible goods may also furnish us cases of fixed- 
supply goods. Thus, if a certain article, e. g., a. hat, goes out of 
style while there is still a considerable stock in existence, then 
all of this stock inevitably passes into the status of supply ; and 
the supply schedule shows the same figure at every price. Thus, 
if there were 10,000 of such hats, the supply schedule would run: 
10m offered at $5; 10m offered at $4.50; 10m at $4; 10m at 
$3.50 ; 10m at $3 ; and so on. 

^2 



CHAPTER IX. NORMAL PRICE. 

Another case under producible goods arises when we are. 
seeking a formula for the normal value of some periodically- 
produced commodity, e. g., wheat, for the interval between two 
harvests. Here substantially the whole stock is bound to be 
disposed of during the period and so is bound to pass into the 
status of supply. Hence the supply schedule for the period as a 
whole would run (supposing 2 billions to be the output) 2 bil. 
offered at $1.50; 2 bil. at $1.45; 2 bil. at $1.40'; 2 bil. at $1.35; 
and so on. 

Finally, producible goods may furnish us such a case of fixed 
supply in certain products the annual output of which is sub- 
stantially fixed, in that production is from the circumstances of 
the case carried to a point beyond which no appreciable addition 
is possible. An illustration of this is to be found in Problem 3, 
page 169, where, under anything like the existing conditions of 
demand, output may be set down at once as about 11,680 pounds. 
And, since the output must in the long run be marketed, the 
supply at the best price available must in the long run be 116.80 
pounds. Accordingly, the important part of the ultimate supply 
schedule would run like this: 11,680 pounds offered at $350; 11,680 
offered at $300; 11,680 at $250; 11,680 at $200; 11,680 at $150; and 
so on. (This case is somewhat difficult, but will be more fully 
cleared up as we advance.) 

The above covers fairly the different cases of normal or ulti- 
mate supply schedules for fixed-supply goods. We must now 
take up the cases arising under varying-supply goods. Here our 
first clue is what we may call the possible output schedule, i. e., 
a schedule showing the several outputs that entrepreneurs stand 
ready to produce at each of a series of prices. For, in normal 
supply schedules, we are dealing with what producers stand ready 
to offer in the long run, and this surely coincides with what they 
stand ready to produce. As an imaginary output schedule, we 
might take the following for silver : miners stand ready to pro- 
duce 290 millions ounces, if price is 58 cents per ounce; 280 mil- 
lions, if price is 57 cents ; 27!0 millions, if 56 cents ; and so on. 
But, again, behind the output schedule, as vital factors in deter- 
mining that schedule, lie the facts of cost. Output will surely 
not be forthcoming at a given price, unless that price covers 

183 



PRINCIPLES OF ECONOMICS 

cost to the entrepreneur;* while, on the other hand, output will 
be forthcoming so long as price does cover cost and the goods 
can be sold, since this means gain to the entrepreneur. Now, the 
facts of cost can be expressed, and are often conveniently ex- 
pressed, in the form of schedules. In some cases these will 
differ from output schedules only in form. Thus, the above 
output schedule for silver is easily transformed into the follow- 
ing cost schedule; if the output is 290' millions ounces the neces- 
sary marginal cost will be 58 cents ; if 280 millions marginal cost 
will be 57 cents; if 270 millions, 56 cents; and so on. Further, 
it is surely obvious that this cost schedule makes the output 
schedule what it is, just as the output schedule makes the nor- 
mal or ultimate supply schedule what it is. Thus, the fact that 
the marginal cost of producing 270 millions ounces is 56 cents 
makes 270 millions the possible output, and so the possible nor- 
mal supply, when price is 56 cents. 

The preceding analysis of normal supply schedules has 
bioi'ight us to the entrepreneur-cost schedule. For the present, 
we shall treat this as the ultimate thing; though it surely is not, 
being in its turn resolvable into certain utility and disutility 
costs. This deeper aspect of the matter, however, will be re- 
served for a latei- section of this chapter. Our immediate task is 
concerned with the more ultimate, but not the most ultimate, 
determination of prices. Every subject of human knowledge 
needs to be studied with varying degrees of thoroughness or 
profundity according to the purpose had in view. Thus, the 
knowledge of the human frame needed for a baseball coach is 
much less than that needed by an ordinary physician; that needed 
by the physician is much less than that needed by a surgeon. 
Our discussion of price-determination is conducted roughly 
speaking, on three levels. The top one is finished ; the deepest 
one will come in the later sections of this chapter; we are now 
concerned with the intermediate one. 

After the stress just laid on the cost schedule as so significant 



*Remember that this includes, not only the money outlay of the 
entrepreneur and an allowance for those contributions of his own which 
could be hired on the market, but also an allowance for his peculiar ser- 
vices as entrepreneur, i.e., an allowance for true profit. See page — ;•. This 
will be our use of the word cost throughout the following discussions on 
normal price. Some authorities deny that there is such a profit in the 
determining costs. 

184 



CHAPTER IX. NORMAL PRICE. 

in determining the normal supply schedule, the student will not 
be surprised to know that the classification of variable-supply 
goods which is usually employed in the study of normal price is 
based on the conditions governing their cost of production. So 
classified, these goods break into increasing-cost, constant-cost, 
and dimxinishing-cost goods. Doubtless this is far from repre- 
senting an exhaustive analysis of the facts of cost; but it brings 
out the distinctions which are of greatest significance in price 
determination. 

How the normal supply schedule for a commodity of the 
increasing-cost class is determined ultimately by its cost sched- 
u'e has just been brought out in illustrating our preliminary 
analysis. Given certain conditions of production which make 
the marginal cost of producing silver 58 cents if the output is 
290 millions ounces ; 57 cents if output is 280 millions ; and so 
on, then an output schedule showing substantially the same 
figures necessarily results, and, finally, from this output schedule, 
a normal supply schedule, also showing substantially the same 
figures, necessarily results.* 

Passing now to the case of diniinishing-cost goods, we wiu 
take as an example the wooden chair which appears in Problem 
9, page 124. From the $3 stage to the 30-cent stage, it is ob- 
viously a commodity which is being produced under the condi- 
tion of diminishing cost, — the more society demands of these 
chairs the more cheaply they can be produced. The matter, as 
given in the original shape, constitutes a cost schedule. From 
this a number of output schedules can be derived; but, for our 
present purpose, the following will perhaps answer best : 

Manufacturers stand ready to produce 
Any number if price is $3 
Any number above 1,000 if price is $2 

20,000" " " $1 
50,000 " " " $.50 
" " " 500,000 " " " $.30 

This of course will answer equally well as a normal supply 



*I hardly need say that this imaginary schedule for silver has a degree 
of symmetry which would probably never be realized in actual life. But 
in economics, as in other sciences, we have cases which have been given 
an artificial simplicity by shutting out confusing conditions. The schedule, 
as it stands, isolates the significant element in this class of cases, vis., the 
fact that increasing output necessarilv means increasing marginal cost. 

185 



PRINCIPLES OF ECONOMICS 

schedule, — the heading being changed to read: manufacturers 
stand ready to offer. 

We come, finally, to constant-cost goods. A good example of 
this would be furnished by this same wooden chair in the 30- 
cent stage; for so long as output is greater than 500,000 but not 
greater than 2,000,000, changing its amount causes no change in 
its cost; and, as this allows for a wide range of demand, such 
constancy of cost is of a really significant sort. Here the cost 
schedule is obviously reducible to a single statement: any num- 
ber between 500,000 and 2,000,000 can be produced at a cost of 
30 cents each. The output schedule is equally simple; manufac- 
turers stand ready to produce any number from 500,000 to 2,000,- 
000, if the price is 30 cents. The normal supply schedule, finally, 
is substantially the same : manufacturers stand ready to offer any 
number from 500,000 to 2,000,000 if the price is 30 cents. Since 
the producers will of course be willing to offer these same quan- 
tities at higher prices, we can develop this single line into a 
many-priced schedule of the usual form, and may find it de- 
sirable to do so. 

Section C. Normal Price of Fixed-Supply Goods. 

We have now before us the principal facts about the kinds of 
normal or ultimate schedules. Our next task is to derive the 
laws of normal price by combining these schedules. In doing 
this, we will begin with the general case of fixed-supply goods, 
represented by land and its uses, Milton's autograph, and so on. 
Let us take the autograph for an example, and suppose that its 
ultimate demand and supply schedules give us the following 
table : 

It is evident on the most cursory survey of this sched- 
ule that price must tend to 
rest at $100, for the final price 
must be one which will secure 
buyers for the whole 10 auto- 
graphs, and $100 is the only 
price which will fulfill this 
condition. (Give the usual 
proof from the impossibility 
of other alternatives.) If we 

suppose the demand schedule 
186 



Demand Price Supply 



1 


$200 


10 


2 


175 


10 


4 


150 


10 


5 


140 


10 


8 


125 


10 


9 


110 


10 


10 


100 


10 


13 


90 


10 


13 


75 


10 



CHAPTER IX. NORMAL PRICE. 

changed so as to read: 3 wanted at $200; 4 at $175; 6 at $150; 
7 at $140; 10 at $125; and so on, then price would necessarily 
tend to rest at $125. Or, again, if we suppose the demand sched- 
ule to become; none wanted at $200 or $175 or $150; 1 wanted 
at $140; 4 at $125; 5 at $110; 8 at $100; 11 at $90; and 
so on, then price would necessarily tend to rest at $90. We can 
not, however, introduce any such suppositions with respect to 
supply; since by hypothesis supply is fixed at just 10 autographs. 

Looking, now, into these results with the object of discovering 
their scientific meaning, it is evident (1) that the price which is 
reached must be one which will make demand at least as great as 
10 autographs; (2) that the price can be changed through causes 
working on demand; and (3) that it can not be changed through 
causes working on the supply, since by hypothesis that supply 
is constant. The second and third points naturally lead us to 
say of goods of this sort that, broadly put, their price is all a 
matter of demand, — supply plays no part in the case. This, of 
course, is not literally true ; since, if the constant supply were 
15 or 5 or 25 or any other number than 10, the price would be 
different. But what we mean is that, under the hypothesis, we 
can properly ignore one whole set of causes which in many cases 
must have a share in determining price, viz., the causes which 
ordinarily determine supply. Again, it obviously follows from 
the above propositions that cost plays no part in determining the 
value of goods like these. For cost manifestly comes into the 
case only in so far as it has power to modify supply. But, as 
just noted, the forces bearing on supply are shut out and so, of 
course, cost is shut out.* 

Returning, now, to the first point made in our interpreting 
paragraph — that a price must be reached which will make de- 
mand at least as great as 10 autographs, — let us set this down in 
the form of generalization as our first formula of normal price, 
— not a very important one, to be sure, but sometimes useful. 

Principle. In the case of fixed-supply goods, that price tends 
to he established which will equate demand to stock or output. 



*This presents no difficulty in the case of non-producible goods such as 
the building sites and Milton's autographs, since these have no cost; but 
the student might be disposed to entertain doubts with respect to the case 
"of wheat between two harvests or the special brand of tea. But we shall 
return to these later and clear up the doubts. 

187 



PRINCIPLES OF ECONOMICS 

But now we must go somewhat deeper. Our discussion of 
ultimate demand schedules on page 179 brought out the point 
that ultimate demand schedules are derived from, determined by, 
valuation schedules. It follows, then, that the price which is 
reached for Milton's autographs represents somebody's valuation 
of those autographs, or at least approximates such representa- 
tion. In particular, it must be as low as the lowest valuation, — 
the marginal valuation — since otherwise the marginal autograph 
would not be bought by the purchaser who gives it that valua- 
tion, i. e., would not be bought at all. Price may, however, go 
below such marginal valuation down to, but not including, the 
iirst sub-marginal valuation. (Let the student prove this.) Ac- 
cordingly, we may state, as another formula for the normal 
price of these fixed-supply commodities, the following: 

Principle. In the case of fixed-supply goods, there tends to 
he established a price which expresses the marginal valuation of 
the stock {output) or anyhow a valuation not higher than the 
marginal and not as low as the first sub-marginal. 

But here, again, it is natural to go a stage deeper. Valuation 
schedules, as we saw on page 180, are only money expressions of 
utility schedules. In saying ifhat $100 is the marginal valuation 
of Milton's autographs, we only say that the marginal buyers 
estimate the advantage, satisfaction, which they would derive 
from possessing said autographs at $100. Accordingly, we may 
substitute for our last formula the following 

Principle. In the case of iixed-supply goods there tends to 

be established a price which expresses the marginal utility of the 

stock {output) or anyhow a utility not higher than the marginal 

and not as low as the first sub-marginal. 

Note : Not a few teachers of economics are disposed to feel 
that, admitting the truth of the principle just laid down, its 
importance is, after all, relatively slight. Marginal utility is not 
a thing we can know in advance or independently of price. We 
know the marginal utility in a given case to be $1, because the 
price is $1. Hence the principle which makes marginal utility 
determine price, gives us no clue to what price will be. It is, 
however, to be said that in some fields the principle may be of 
considerable significance. Thus, one may contend very plausibly 
that a given economic order is expedient and right, because it 
tends to secure a determination of prices according to which 
those prices express the relative marginal utilities of goods. 
But we shall recur to this in another connection. 

188 



CHAPTER VIIT. SUPPLY AND DEMAND. 
Illustrative Problems. 

1. During the current year, there came on the market from 
various sources twelve specimens of a certain rare object. If 
the ultimate demand schedule proves to be as foUov^s : 1 w^anted 
at $60; 2 more at $55; 4 more at $50'; 5 more at $45; 6 more at 
$40; etc., what price will in the long run tend to be reached? 
Prove. 

2. In a certain year the output of wheat proved to be 2,000 
millions of bushels. The ultimate demand schedule for the year 
ensuing till the next harvest was as follows : 1,600 mil. bu. 
wanted if price were $1.30; 1,800 mil. if price were $1.25; 2.000 
mil. if $1.20; 2,200 mil. if $1.15; and so on. 

(a) What price would tend to prevail for that year? Prove 
in detail. 

(b) What would determine it? 

(c) What price would tend to prevail, if the demand moved 
up a step, making the schedule 1,800 mil. at $1.30; 2,000 mil. at 
$1.25; 2,200 at $1.20; 2,400 at $1.15; and so on? 

(d) What price if demand moved up two steps, making the 
schedule: 2,000 mil. at $1.30; 2,200 at $1.25; and so on? 

(e) What price if demand moved down two steps, making 
the schedule: 1,200 mil. wanted at $1.30; 1,400 mil. at $1.25; 1,600 
at $.20; 1,800 at $1.15; 2,000 at $1.10; and so on. 

3. Suppose we were dealing with a longer period than one 
year and the average annual supply schedule was of the variable 
kind, running as follows : 2,400 mil. bu. furnished if price were 
$1.30; 2,200 mil. if $1.25; 2,000 mil. if $1.20; 1,800 mil. if $1.15; 
and so on. 

(a) Supposing the average annual demand schedule to be the 
first one given under Problem 2, what would the long-run price 
tend to be? Prove. 

(b) Supposing the demand schedule to be as in Pr. 2 (d), 
what price would tend to prevail? 

(c) Compare this result with that reached in Pr. 2 (d), and 
point out the difference in the processes whereby prices are 
determined in the two cases. 

4. There are in a certain city 11 business sites of a certain 
grade, each of which could be used for a variety of purposes, 
and would give off a different yearly income according to the 
particular use to which it was put. The schedule for these 
different possible annual uses is as follows: 1 giving a net in- 
come of $7,000; 5 others giving a net income of $6,000 each; 2 
giving $5,000 each ; 4 giving $4,000 each ; 2 giving $3,0'00 each ; 2 
giving $2,000 each; and 3 giving $1,000 each. 

(a) Make out the ultimate demand schedule in tabular form. 

(b) What will the rent of one of these sites tend to be? 
Prove. 

189 



PRINCIPLES OF ECONOMICS 

(c) What would it tend to be if there were 13 of them? 
Prove. 

5. Suppose that the supply and demand schedules for the 
rare brand of tea which you get from Problem 3, page 169, are 
identical with the ultimate schedules. 

(a) What must the normal price of this brand of tea tend 
to be? Prove. 

(b) What would it be if the supply schedule changed to read 
as follows: 11,000 pounds if price is $1; 11,500 if $2; 11,600 if 
$5 ; after which no increase in supply will take place whatever 
the price? 

(c) This last example shows that a particular element 
which often shares in the fixing of price, in this tea case plays 
no part, leaving the work to be done by marginal utility. What 
is the excluded element? 

6. "In 1848-49 the black death carried off from one-third to 
one-half of England's workingmen. In consequence wages greatly 
advanced." 

(a) Explain the advance in wages on the basis of the Law 
of Supply and Demand given on page 176, constructing for the 
purpose imaginary demand and supply schedules. 

(b) Explain the advance in wages on the basis of Marginal 
Utility principle given above. 

(c) Discuss this statement: "Wages rose because the de- 
mand for the laborers who were left had greatly increased." 

Section D. Normal Price of Variable-Supply Goods 

In the section just preceding, we discussed what were called 
fixed-supply goods, meaning goods the ultimate supply of which 
for its normal price period is substantially determinate — can not, 
economically speaking, change. These goods are strictly non- 
producible, or non-producible during the normal price period, or 
producible only under such conditions that, unless a quite ab- 
normal change in demand should take place, their output is sub- 
stantially fixed. We must now consider that large class of goods 
which are producible under such conditions that, within any 
range which demand is at all likely to traverse, their output is 
capable of almost indefinite contraction or expansion, and the 
supply offered can and will change with changing circumstances. 
Goods of this class we have already classified as increasing-cost, 
constant-cost, and diminishing-cost goods. We will begin with 
the constant-cost class. 

As an example of constant-cost goods we will take the wooden 
chair, the ultimate supply schedule of which was discussed on 

190 



CHAPTER IX. NORMAL PRICE. 

page 185. As already pointed out, this is a constant-cost com- 
modity only while demand ranges between 500,000 and 2,000,000; 
since before that cost is diminishing with increased output while 
later it is increasing. Since producers will of course stand ready 
to supply at prices above 30 cents as many chairs as they would 
at that figure while below 30 cents they will supply none, it is 
possible to fill out a many-price supply schedule of the usual 
form; and this is perhaps desirable. Let us now make such a 
supply schedule and combine it with several demand schedules, 
as a result of which we have the following table : 



SUPPLY. , . 


. PRICE 




DEMAND 000 






000 


Dollars 


Sch.A 


Sch.B 


Sch. C 


Sch. D 


Sch.E 


500-2000 


3 


2 


3 


3 


5 


4 


500-2000 


2 


10 


12 


15 


20 


17 


500-2000 


1 


50 


51 


60 


80 


70 


500-2000 


.75 


300 


500 


810 


1100 


963 


500-2000 


.50 


500 


750 


1020 


1400 


120O 


500-2000 


.40 


600 


895 


1200 


1520 


120O 


500-2000 


.30 


700 


950 


1540 


1840 


1200 





.25 


lOOO 


1210 


2000 


2560 


1200 





.20 


150O 


180O 


2560 


2800 


1200 





.15 


2500 


3000 


3800 


4563 


1200 



If, now, we combine the supply schedule of this table with 
demand schedule A, we see at once that a price of 30 cents must 
tend to prevail. If proof is needed, it is found along the lines 
already followed. The price can not be higher than 30 cents, say 
40; because at that price demand will be less than supply at 30 
cents, and sellers at the last figure competing to get the market 
will bring price down to that point. On the other hand, price 
can not be below 30 cents, say 25; because at that price supply 
will become zero and so vastly less than demand at 30 cents, as 
a consequence of which, buyers at the last figure, in order to get 
their wants supplied, will raise price to that point. 

Similar reasoning will show that under demand schedules B, 
C, and D, also, a price of 30 cents will tend to prevail. That is, 
in the case before us, price will always be 30 cents whatever be 
the demand, provided only that it ranges somewhere between 
one-half million and two millions. In other words, speaking 
broadly, demand has here no part in the immediate determina- 

191 



PRINCIPLES OF ECONOMICS 

tion of normal price, just as in the case of fixed-supply goods 
supply has no part in the immediate determination of nor- 
mal price. (See page 187.) Further, the element on the supply 
side of the matter which is determinative in the case, is cost; 
for our supply schedule in this problem was based on the cost 
schedule. Price is 30 cents because that sum covers cost to pro- 
ducers. 

This last statement may, however, seem too strong. The 
reader may object to making cost the cause of a 30-cent price, 
on the ground that this price expresses the marginal utility of 
the chairs as well as their marginal cost. Thus, in Schedule A, 
there are 100,000 chairs which are wanted only provided the 
price is as low as 30 cents; in Schedule B there are 55,000 such; 
in Sch. C, 340,000; and in Sch. D, 320,000; and the utility of these 
chairs, the marginal utility of chairs in general, is obviously 30 
cents. Price, in short, coincides with marginal utility just as 
much as with marginal cost. Can it not, therefore, be plausibly 
contended that marginal utility plays just as much of a part in 
the immediate determination of normal price as does marginal 
cost? The decisive answer to this is found in Schedule E. 
Here, as before, a price of 30 cents must tend to prevail, — the 
competition of sellers will keep it as low as this and the disap- 
pearance of supply, if price goes below 30 cents, will keep it as 
high as this. But, while price remains 30 cents as before, mar- 
ginal utility rises to 50 cents; for no increase in demand takes 
place as price falls below this point, showing that the lowest use 
to which the chair is put is a fifty-cent use. Thus, it is not 
necessary that price should coincide with marginal utility; and 
so. of course, it can not be determined by marginal utility. 

The preceding discussion has brought us to the point of 
affirming, for the case before us, a necessary relation between 
normal price and cost of production,, without recognizing the 
possibility that cost of production may be an ambiguous phrase. 
Thus, it is assumed that, while the chaip industry is in the 
30-cent stage all chairs produced have a cost closely approximat- 
ing this figure. But it will often happen in an ever-changing 
industrial society that, while the cost which under existing con- 
ditions must be thought of as normal equals a certain sum, pro- 
duction is still going on at costs higher than this. Some pro- 

192 



CHAPTER IX. NORAIAL PRICE. 

ducers of chairs, perhaps, are getting them out at a cost of 33 
cents or 35 or even more. This grows out of the fact that some 
producers have not yet been able to adopt the methods through 
which the lowering of cost to 30 cents has been effected; and 
possibly they will never be able to do so. Thus, it appears that, 
even in the case of what we have called constant-cost goods, 
there may be several costs existing side by side ; — if costs are in 
a sense constant they are not necessarily uniform. Under these 
circumstances, it seems scarcely sufficient to say that price must 
tend to equal cost. We need to specify what cost. 

The preceding paragraph shows that cost in our present con- 
nection needs some definition. What that needed definition is, 
one can easily perceive. A very little reflection must show that 
among the possible costs of chairs above set down— 30 cents, 33 
cents, 35 cents, and so on,— 30 cents is the one which tends to 
determine price; for by hypothesis output at this cost can be 
increased to an amount which is substantially unlimited, consid- 
ering the assumed conditions of demand, and hence the com- 
petition of manufacturers producing at this cost will expand 
output till price reaches this point,— will, in fact, drive manu- 
facturers producing at higher costs to improve their methods or 
go out of business. It thus appears that, in a general way, the 
cost which tends to equal is the lozvest one at which the output 
demanded can be furnished. But it may be questioned whether, 
for our present purpose, this is not somewhat more definite than 
is desirable. The conditions of actual production do not realize 
such definiteness and precision of gradation in cost as has been 
all along assumed. Even among the efficient and really signifi- 
cant producers, there are slight differences in cost. On this 
account it is perhaps best to 'follow the practice which declares 
that price in the case under consideration tends to equal cost to 
representative producers. 

Another comment with respect to the price-determining cost 
ought, perhaps, to be made. The cost we are here dealing with 
is what was earlier (p. 52) called "entrepreneur's cost,"— f^., 
the actual money outlay of the entrepreneur, the expression in 
money of those labor, land, and capital services which he might 
hire from others but actually supplies himself, and the expres- 
sion in money of the estimate which he places upon the non- 
193 



PRINCIPLES OF ECONOMICS 

purchasable part of his own contribution to the result. In 
simpler language, cost, as we understand it, includes, not only 
cost in the popular sense, but also such an amount of pure 
profit as is necessary to insure the entrepreneur's continuance in 
the business.* 

One other point ought to be noted before closing this dis- 
cussion. The principle brought out, like any other, assumes 
substantial constancy in conditions. In particular, it assumes 
that the commodity under consideration in a given case con- 
tinues to be wanted by consumers. The price of a hat which 
has gone out of style is determined by its utility only. 
Summarizing this discussion, we get the following 
Principle. The normal price of constant-cost goods, the 
continued production of which is demanded, must approximately 
equal their cost to representative producers. 

Note : In the discussion just closed, it has been assumed 
that the money prices of cost goods are fixed in advance of their 
use in production and so, setting out from this starting point, 
cost can move forward to fix prices. The entrepreneur, we 
have implied, finds the wages, interest, rent, and so on which he 
must pay, determined in advance ; and so the amount of his 
cost comes, to be entirely a question of how much labor service, 
capital service, land service, and so on he needs to produce the 
commodity. If such an assumption were really true, it would 
anyhow be evident that we have not yet reached the end of our 
task, — that the ultimate forces determining prices are not yet 
disclosed; for we should still need to find out how the prices 
of the ultimate cost goods were determined. As a matter of 
fact, however, it surely is not true in the full sense that the 
prices of the ultimate cost goods are determined in advance of 
their use in production. Such use of those cost goods must 
surely have some share at least in the determining of their 
prices. If the employer finds himself getting unexpectedly high 
prices for the products which labor helps him to put out, in 
some cases certainly he will sooner or later find himself obliged 
to pay a higher price for that labor, i.e., to incur a higher cost. 
In a word, we seem to be involved in a circle, — ^the prices paid 
for cost goods determine the prices of product goods, where- 
upon the prices of product goods react to determine the prices 
of cost goods. 

The difficulties suggested by the preceding paragraph are 
real and, from some standpoints, they are important. Neverthe- 
less, the principle above -laid down, that price tends to equal 



*Wh2ther there is any such profit, is still a mooted question. 

194 



CHAPTER IX. NORMAL PRICE. 

cost, is universally admitted to be true for practical purposes 
and by rnost economists is also held to be of great significance 
for practical purposes. The business manager, the prospective 
investor, the prospective buyer, the statesman concerned with the 
levying of taxes, and so on, — all these will constantly find them- 
selves called on to act as if, for their purposes, the principle we 
have laid down were the last word. Thus, if the manufacturers 
of a certain commodity are able to put it on the market in 
indefinitely large amounts at a cost of $3, they would be very 
foolish indeed to expect the price to remain at any figure 
materially above $3, even though for many months it had been 
in the neighborhood of $5. Again, if, when a certain commodity 
is being put on the market by representative producers at a 
cost of 50 cents per unit and is selling at that figure, govern- 
ment levies on its production a tax of $1.50^ per unit, thus 
making _ it cost substantially $2.00, its price will almost cer- 
tainly rise to approximately that figure. In a later connection, 
we shall try to clear up some of the difficulties suggested above. 
But, for the present, it is our business to impress this upon the 
student^ that, however much the principle of cost falls short 
of furnishing an ultimate explanation of values, that principle is 
after all of real and great importance in the actual conduct of 
economic life. 

Illustrative Problems. 

1. Suppose the conditions for producing Portland cement to 
be such that any quantity from 5 millions barrels to 50O millions 
can be put on the market at a minimum cost of about $1.15 per 
barrel ; while any output from 500 millions to 800 would cost 
$1.25 per barrel. 

What would price tend to be under each of the following 
demand schedules? Marginal utility? 

PRICE DEMAND 000,000 

A B C D E F 

3.00 1 30 5 15 5 20 

2.50 2 75 15 25 15 50 

2.25 5 100 25 44 35 70 

2.00 10 200 40 60 43 100 

1.75 11 400 60 100 75 200 

1.50 13 GOO 75 200 180 350 

1.25 15 700 75 300 200 450 

1.15 20 800 75 367 263 495 

1.10 25 lOOO 75 400 300 550 

1.05 30 1100 80 430 320 600 

1.00 50 1500 100 500 400 80O 

2. "Let us suppose that five or six concerns are supplying 
the building brick used in a certain district, and that by a new 
method of manufacture they manage to double their output for 

105 



PRINCIPLES OF ECONOMICS 

the former expenses of labor. What will happen as regards 
the price of brick? From our knowledge of what competition 
usually does, we are apt to say: the price of brick will fall 50 
per cent. This may be the final result, but not necessarily so, 
and at any rate the movement of price is instructive. The 
manufacturers are now able to sell at half the price if they 
wish, but it is their interest to keep up the price as long as 
they can. What, however, will certainly happen, in normal 
circumstances, is that they will increase their production of 
produce, men will desire ; it is, rather, that what man wants he 
brick. But it is not the case that, whatever nature and man 
usually sets nature and man to produce. To take off the extra 
supply of brick, then, the manufacturers must find a wider 
circle of demand than before ; but there is nothing to lead us 
to suppose that there is any wider circle of demand at the old 
price. What we may safely suppose is that a great many new 
people will buy brick for building purposes if they can get them 
cheaper, but, in any case, the decision lies absolutely with them 
whether they will take more or not. It is easy to fail into the 
mistake of thinking that there will be a demand for everything 
produced if it is sold at a reasonable price, but this idea simply 
arises from the fact that producers anticipate desire and tempt 
demand. In the present case demand must come from some 
level of want which was not satisfied at the former price, and 
is ready waiting to take up the extra supply if the price is 
brought down. 

*Tf, however, as may well happen — not in the case of brick 
probably, but in large articles of limited consumption — there is 
no such circle of demand at lower levels, what will happen is 
that the manufacturers will cut down their output to the same 
quantity of brick as before, and maintain the former high price. 
For brickmakers, like other business men, do not put themselves 
on 'salaries,' and give the public the benefit of a 1 cheapening of 
production. It is characteristic of the capitalistic employer in 
all departments that he speculates on having a profit, and thinks 
no profit too high, just because, as a speculative gain, it may be 
balanced any year by as great a loss. It is contrary, then, to 
all experience to think that employers will vo untarily reduce 
prices — any more than they will voluntarily raise wages or pay 
higher interest — because costs have decreased. They only do 
so under compulsion of fear that their rivals will cut the feet 
from under them. Where competition is active it will often seem 
as though reduction of costs were almost immediately followed 
by fall in prices of products, but, in the last resort, — and that 
is what concerns us in seeking for a universal law of value — 
the new prices are determined hy the lower and wider levels of 
want which are ready to take up increased supply of the majority 
of ordinary commodities." . , 

The above quotation is taken from the writings of an able 

196 



CHAPTER IX. NORMAL PRICE. 

economist. It has been modified at a few points to eliminate 
ambiguities. I think, however, that it does not misrepresent his 
views. In any case, it brings out a way of looking at the mat- 
ter which the student should be familiar with. 

(a) State clearly what is the precise point which the author 
seems to be trying to make. 

(b) Show that it is unsound. 

3. At a certain time the price of whiskey in this country was 
about fifty cents, the cost of producing it. The United States 
government thereupon levied on each gallon produced a tax of 
one dollar. What naturally happened to the price of whiskey? 
Why? 

4. From a cement factory promoter in 1901: "We can easily 
satisfy any fair-minded person that our proposition is a veritable 
gold mine. Cement can be put on the market by a well- 
equipped mill at a cost of about $1.75 a barrel, while it is selling 
for $4, thus giving a profit of over 100 per cent. With the supply 
of raw material practically unlimited, our mill will soon be 
turning out 600,000 barrels per year, and our annual profits will 
be nearly $1,500,000. You can't afford to stay out." 

Supposing the facts to be as stated, what economic law was 
overlooked in drawing conclusions? 

5. A certain residence in Ann Arbor is taxed each year, let 
us say, $42, of which sum $12 is properly chargeable to the land 
while the remaining $30 is chargeable to the house. Under the 
operation of the two principles of normal price which we have 
now had, the $30 will really be paid by the tenant, being shifted 
from the landlord to him, while the $12 will not be shifted and 
so, as far as the future is concerned, will remain on the land- 
lord. 

Explain how it is that things come out this way. 

6. "Labor once spent has no influence on the future value of 
any article." 

(a) Show that this is true as applied to the wooden chair 
which was used in working out our principle. 

(b) Does the above statement, admitting it to be true, in- 
validate our principle as laid down on page 195. 

7. Suppose that the rare brand of tea which appears in Prob- 
lem 5, page 190, is produced in China and that the Chinese gov- 
ernment levies a tax of $50 a pound on all produced. 

(a) What effect will this tend to have on its price? 

(b) Who will bear the burden of this tax? 

(c) Construct an output schedule under which the tax would 
raise price. 

8. Suppose our government levies a tax of $1 per barrel on 
the cement which figures in Problem 1, page 195. Where will 
the burden of this tax tend to rest? Prove. 

197 



PRINCIPLES OF ECONOMICS 

9. At a certain time buggies of a certain type are selling at 
$65, the cost of production to makers working with the poorest 
facilities. At the same time other classes of producers can get 
these buggies out in practically unlimited quantities at costs 
ranging all the way down to $35. What price must in the long 
run tend to be established? Why? 

10. Suppose that the buggies which appear in the last prob- 
lem go out of style so generally that the number already man- 
ufactured considerably exceeds the demand. What will the price 
of these buggies tend to be under this new condition? Explain. 

Thus far our discussion of varying-supply goods has been 
confined to those belonging to the subdivision known as con- 
stant-cost goods. We will next take up the case of increasing- 
cost goods illustrated by silver. Let the following table repre- 
sent a portion of the ultimate or normal supply schedule of 
this metal and corresponding portions from several different 
demand schedules. 

DEMAND 000,000 OZ. 

B 

230 

240 

250 

260' 

270 

280 

290 

A cursory examination of this table shows us that under 
demand schedule A price must tend to be 54 cents; under B, 
55 cents; under C, 56 cents; under D, 53 cents; and under E, 
52 cents. That is, practically every change in demand causes a 
change in price. Accordingly, we can not say, as in the preced- 
ing case, that forces coming from the side of supply alone de- 
termine price. Again, we note that in every case price coin- 
cides with marginal valuation or utility, whereas in the case of 
constant-cost goods it was possible for price to be below marginal 
utility. In this case, therefore, we must not say that price is 
determined, even immediately, without regard to marginal utility. 
But here we must be careful not to go too far. Demand and 
utility play a part in the case before us ; but they do not play all 
the parts. Supply and cost come in also. Demand in Schedule 
B moved up two steps above what it was in Schedule A; but 

198 



SUPPLY 


PRICE 




000,000 oz. 


cents 


A 


290 


58 


210 


280 


57 


220 


270 


56 


230 


260 


55 


240 


250 


54 


250 


240 


53 


260 


230 


52 


270 



c 


D 


E 


250 


190 


170 


260 


200 


180 


270 


210 


190 


280 


220 


200 


290 


230 


210 


300 


240 


220 


310 


250 


230 



CHAPTER IX. NORMAL PRICE. 

price moved up only one step. Compare this with the case of 
fixed-supply goods as illustrated in the table below, which we 
will suppose to represent a section from the ultimate schedule of 
some rare painting, — of which there are 10 originals, — and cor- 
responding sections from several demand schedules. 



SUPPLY 


PRICE 






DEMAND 








000 dollars 


A 


B 


c 


D 


E 


10 


100 


6 


8 


10 


4 


2 


10 


90 


7 


9 


11 


5 


3 


10 


80 


8 


10 


12 


6 


4 


10 


70 


9 


11 


13 


7 


5 


10 


60 


10 


12 


14 


8 


6 


10 


50 


11 


13 


15 


9 


7 


10 


40 


12 


14 


16 


10 


8 


10 


30 


13 


15 


17 


11 


9 


10 


20 


14 


16 


18 


12 


10 



Here the demand in Schedule B moved up two steps from 
that in Schedule A ; and price also moved up two steps. That is, 
in this case a change in demand found itself able to influence 
price without interference on the side of supply. In the case of 
the silver, on the contrary, the new demand had to reckon with 
a new supply brought out by the change in price ; and this new 
supply permitted price to advance only one step. Further, in 
the case of silver, under every one of the" different demand 
schedules the price represented the marginal cost of the metal 
as well as its marginal utility. And this was no accident, as it 
was in the case of the rare brand of tea. (See page 190). The 
price was not fixed at 55 cents under Schedule B without respect 
to marginal cost, which therefore adjusted itself to the price thus 
fixed. If we suppose production to cease at all costs above 54 
cents, so that the supply schedule would read (upwards) : 250 
millions at 54 cents ; 250 millions at 55 cents ; 250 millions at 56 
cents ; 250 millions at 57 cents ; and so on, thus making silver a 
fixed-output commodity — one which really has its price deter- 
mined by marginal utility solely — , then price under Schedule B 
would rise above price in Schedule A, not one step, but two 
steps, i.e., it would be 56 cents rather than 55. In short, under 
the original hypothesis, the price for Schedule B was 55 cents 
because this was the marginal cost, just as much as because it 

,199 



PRINCIPLES OF ECONOMICS 

was the marginal utility. In fact, for cases like this one of 
silver we should affirm that the price must be one which ex- 
presses at once the marginal utility and the marginal cost. 

Because of the fact brought out in this last statement, we 
can truthfully declare either that price must express marginal 
utility, or that price must equal marginal cost. But in making 
the former statement, we must not understand ourselves to 
mean that price is determined by the utility of the commodity 
without respect to its cost; for of course the marginal utility is 
what it is because, among other things, costs are what they are, 
and that marginal utility must finally rest at a point which makes 
it coincide with marginal cost. In like manner, in making the 
statement that price must equal marginal cost, we must not 
understand ourselves as dec-aring that price is determined by 
the cost of the commodity without respect to its utility; for of 
course the marginal cost is what it is because, among other 
things, utilities are what they are, and that marginal cost must 
finally rest at a point which makes it coincide with marginal 
utility. Accordingly, it can not properly be said of the class of 
commodities with which we are now dealing that their price is 
fixed by their marginal utility, to which -price marginal cost 
thereupon adjusts itself, or that their price is fixed by marginal 
cost, to which price marginal utility thereupon adjusts itself. 

Putting the points made in the preceding discussion into 
formal shape, we have the following 

Principle. The normal price of increasing cost goods, the 
continued production of which is demanded, tends to be a price 
which expresses at once the marginal utility of the output and 
its normal marginal cost. 

Note : In the above formula the word "normal" is inserted 
before marginal cost to anticipate an objectionable interpretation 
which some have made. It is this that the marginal cost is 
literally the greatest cost at which production is being carried 
on, including cost to producers who are quite behind the times 
in methods and facilities and are perhaps losing money all the 
time but have no other alternative than going on until they are 
completely bankrupt. Such persons are not marginal producers 
in any proper sense. They are wholly abnormal elements, hav- 
ing little or no significance in the case. Since by hypothesis they 
do not quit production when it becomes unprofitable, their cost 
is not a determining factor in respect to price. 

200 



CHAPTER IX. NORMAL PRICE. 

Illustrative Problems. 

1. Suppose that the production schedule of silver reads as 
follows: at a marginal cost of 55 cents, 170 millions ounces can 
be furnished ; at a marginal cost of 56 cents, 175 millions ounces ; 
at 57 cents, 180 millions ; at 58 cents, 185 millions ; at 59 cents, 
190 millions ; at 60 cents, 195 millions ; at 61 cents, 200 millions ; 
at 62 cents, 205 millions ; at 63 cents, 210 millions ; etc. Suppose, 
secondly, that the demand schedule is as follows : 160 millions 
ounces wanted, if price is 65 cents ; 165 millions, if price is 64 
cents; 170 millions, at 63 cents; 175 millions, at 62 cents; 180 
millions, at 61 cents ; 185 millions, at 60 cents ; 190 millions, at 
59 cents ; 195 millions, at 58 cents ; 200 millions, at 57 cents ; etc. 

(a) Make out a table giving the ultimate demand and supply 
schedules. 

(b) What must price tend to be? Prove. 

(c) What will it tend to be if demand moves up two steps, 
becoming : 170 millions wanted if price is 65 cents ; 175 millions 
if price is 64 cents ; and so on. Prove. 

(d) What determines price in these two cases? 

2. "At the present time (1896) silver is being produced at a 
marginal cost of approximately 65 cents per ounce. But the 
price of silver is in the long run determined by its marginal 
cost. Hence it is ridiculous to expect that the adoption of free 
coinage by the United States will raise the price of silver, as 
measured in gold, to $1.29 per ounce, or any other figure above 
65 cents." 

Admitting that the normal price of silver must in the long 
run coincide with marginal cost, still the above conclusion is 
unsound. Explain. 

3. Starting with Problem 1, in its original form, suppose that 
the government puts on every ounce of silver costing less than 
50 cents a tax of 4 cents. This tax will of course be paid in the 
first instance by the producers of silver. 

(a) Will it be borne by them in the end or be shifted to 
consumers? Give the argument. 

(b) What will the new price be? 

(c) Compare this result with that appearing in Problem 8, 
page 197. 

4. Suppose the government were to levy a tax of 4 cents per 
ounce on all silver produced; and answer the same questions as 
under 3. 

5. Suppose the production schedule in Problem 1 to be 
changed so as to read as follows : at a marginal cost of 55 
cents, 175 millions ounces can be furnished; between 55 cents 
an«d 59 cents no change is possible ; at a marginal cost of 59 
cents, 500 millions ounces can be furnished; at 60 cents, 525 
millions ounces ; and so on. 

201 



PRINCIPLES OF ECONOMICS 

(a) What would price tend to be when the demand schedule 
was the same as in Problem 1 (b) ? Prove. 

(b) What would price tend to be if the demand schedule 
were moved up as in Problem 1 (c) ? Prove. 

(c) What would price tend to be if the demand schedule 
were moved up two more steps so as to begin: 190 mil. oz. 
wanted at 65c.? Prove. 

(d) What is the point to be made? 

6. The author of a recent text-book in Economics expresses 
himself on the relation of cost to price in this vein: In the 
case of reproducible goods, "cost of production seems of com- 
manding importance.' "In fact, however, marginal efficiency 
(utility) is the real determinant of price," "cost of production 
adjusts itself to this." "There is an abundance of silver below 
the surface that is not mined because it will not pay; if the 
marginal efficiency or value of silver should rise, these more 
expensive grades would at once be marketed and the new mar- 
ginal cost of production would adjust itself to the price." 

(.a) Construct a sentence running parallel to the last one 
quoted, but exactly reversing the roles of marginal utility and 
marginal cost, whereby it would seem to be proved that mar- 
ginal cost really determines price while marginal utility merely 
adjusts itself to price. The sentence should start out some- 
thing like this : "Generally speaking, it would seem as if niar- 
ginal utility chiefly regulated price. In fact, however, marginal 
cost is the real determinant; marginal utility adjusts itself to this. 
Below the present demand for silver there are numerous layers 
of demand which are now merely potential because the corre- 
sponding utilities are below the present market price; if, now. 
the marginal cost of producing silver should fall, and so the 
price should fall, these lower layers of demand, etc. . . ." 

(b) Show that both the original quotation and our substi- 
tute are inadequate. Construct imaginary schedules to illustrate 
your argument. 

We have brought out the laws of normal price for constant- 
cost and increasing-cost goods. It seems necessary to say a 
word with respect to diminishing-cost goods; though) as will 
appear in a moment, the principle involved in the case is not 
greatly different from that governing constant-cost goods. As 
an example of such goods, we will use, as before, the wooden 
chair from the $3 stage of the schedule down to the SO-cent 
stage. In the first place, it is evident that, during much of the 
time while the industry is paissing through these stages, these 
chairs are really constant-cost goods, as the class was defined 
in an earlier connection, page 186. Thus, while demand is smaller 

202 



CHAPTER IX. NORMAL PRICE. 

than 1,000 chairs per year, cost is constant at $3 ; and, since it 
is possible to imagine a social condition in which demand would 
remain for a long period under this figure, it is possible to 
imagine a condition in which this chair is a constant-cost com- 
modity having a cost of $3. In like manner, if demand at $2 
should for a considerable period range between 1,000 and 20,000 
chairs per annum, then during such period this chair would be a 
constant-cost commodity. Similar statements could be made for 
the $1 stage and the 50~cent stage. In fact, the chair has to be 
looked on as a diminishing-cost good, only when, and because, 
circumstances are such that there is likely to take place a 
change in demand sufficiently great to cause a change in the 
scale on which production is conducted. It may be that de- 
mand is about to increase so much as to justify a resort to 
production on a larger scale, or to decrease so much as to 
compel return to a smaller scale. In the former case, price will 
certainly tend to fall to the cost of production characteristic 
of the enlarged scale. In the latter, price will certainly have 
to rise to the cost of production characteristic of the smaller 
scale. A change of this latter sort is doubtless less probable 
than one of the former ; but it is always possible. Now, it may 
plausibly be argued that the principle laid down for the case of 
constant-cost goods covers with sufficient precision this one of 
diminishing-cost goods. For that principle makes price tend to 
equal cost to representative producers, and it might perhaps rea- 
sonably be claimed that the representative producers are those 
who have adopted the large-scale methods justified by increased 
demand. However, something is to be said in favor of a more 
precise method of statement. Hence we give the following 

Principle. The price of dinmiishing-cost goods tends to 
equal their cost to producers ivorking on the largest scale justi- 
fied by the existing conditions of demand, — monopoly being 
excluded. 

Section E. The Normal Price of Non-Producible Income- 
Bearing Properties 

It is probably a safe statement that every case of normal 
price under free competition is more or less adequately covered 
by the principles already laid down. But in not a few cases 
we are able to set forth more specific, and so more useful, 

203 



PRINCIPLES OF ECONOMICS 

formulae because of special circumstances affecting the partic- 
ular case. 

It is of course possible that producible goods such as auto* 
mobiles, threshing machines, launches, canoes, carriages, etc., 
should be income-bearing goods. Further, being producible 
goods, and producible goods of the subclass constant-cost, their 
price will in the long run follow their cost. Still, it would be 
hard to believe that there is no relation between their price and 
their income. Under the operation of several economic forces 
working out through numberless transactions, it comes to be 
true that a given sum of capital, say $1,000, will give off $50 
income. Consequently, there is bound to be a similar relation 
between the price of a durable piece of property and the net 
money income which it gives off. If a given automobile which 
is hired out is worth $2,000, then we can be pretty sure that the 
net income — i.e.^ the income after due allowance has been made 
for repairs, replacement, labor services, and so on — will in the 
long run be not far from $100. That is, between the price of 
such a machine and its net income, there must tend to be a 
ratio substantially equal to the current rate of interest. But, 
if this is so, one of these two things, the price or the net in- 
come, must be free to move and so able to put itself in the 
required relation to the other. In the case of the automobile, 
the one which must do this is surely the net income; for, as 
we have just remarked, the price is fixed by cost of production 
and so is not able to move at all. The income, however, finds 
no difficulty moving. If the net incomes derived from renting 
automobiles are too large considering the price of machines, 
then competition will increase, and rentals, and so incomes, will 
decline. If incomes are too small, competition will fall off, 
and rentals, and so incomes will increase. Accordingly in the 
case of producible income-bearers, the price of the income- 
bearer is first fixed and to this price the net income is ad- 
justed.* 

Passing, now, to the case of non-prodiicihle income-bearers 



*The student must remember, however, that the price of constant-cost 
g^oods is not always governed by cost, A necessary condition was ex- 
pressed in the phrase, "the continued production of which is demanded," 
which, appears in the formula on page 194 Producible income-bearers at 
times pass into the status of non-producible ones. But these exceptional 
cases will be considered later. 

204 



CHAPTER IX. NORMAL PRICE. 

such as land, we find ourselves facing a very different problem. 
Here there is no cost to come into the matter. Utility only can 
affect price; and the particular utility v^hich has to be con- 
sidered is quite obviously the service given off by the land for 
a certain definite time. That is, the first thing to be fixed is, 
not the price of the land as a whole, but the price of a year's 
use of the land, i.e., its income; which income, having been 
fixed, determines in some way the price of the land itself. But 
here again, as in the case of producible income-bearers, the 
relation between the price of any particular income-bearer and 
its income is fixed in advance* by the existing ratio between 
capital in general and the income therefrom. When 5 per cent 
is the prevailing rate of interest, we can be pretty sure that 
the net yearly income of a piece of ground which commands 
a price of $1,000 must be about $50. So far the case of the 
piece of ground and the automobile are alike. But, when it 
comes to causation, the cases are quite different. The income 
of the machine adjusts itself to its price or cost; the price of 
the land adjusts itself to its income. We can not say : the land 
is worth $1,000, hence its net income must be $50. Rather, we 
must say: the net income of the land is $50, hence its value 
must be about $1,000. If, now, we formulate the point brought 
out in the preceding discussion, we have the fo'lowing 

Principle. The price of an income-bearing property not 
capable of duplication tends to equal the sum of money which 
at the current rate of interest zvould yield a yearly income equal 
to the 7iet yearly income of the said property. 

Illustration. Suppose a certain building site regularly yields 
a net income of $100, and that the current rate of interest on 
long-time loans is about 5 per cent. Then, the price of the site 
wi 1 tend to be as many dollars as .05 is contained in 100, i.e., 
$2,000. (The usual procedure, when 5 per cent is the rate, is 



*This is not to say that the particular case under consideration plays no 
part in determining the ratio betwe n capital in general and the incom ■ 
th r:"^"iQm. Do'.ih^l ss eve^ y transaction involving an exchange of present 
wealth for the right to a seri s of future incomes has some share in fi :in : 
the rates at which such exchanges take place. But, as we have already 
seen, the price-making forces come to a head, so to speak, in a particulnr 
class _ of transactions, vis., those which are marginal, — those in whi'^'i 
marginal utility or marginal cost or both are determined. Accordingly, we 
can safely treat almost any particular transaction involving the exchange 
of present wealth for a seri s of future incomes as one to which is being 
applied a ratio of exchange which has already been determined elsewhere. 

205 



PRINCIPLES OF ECONOMICS 

to multiply the income by 20, which is the same thing as divid- 
ing it by .05, since five hundredths equal one-twentieth.) 

Illustrative Problems. 

1. If a certain mining stock pretty generally yields a net 
income each year of $54 per share, what would its price tend 
to be, supposing that the usual rate of return expected in such 
lines of industry is about 7 per cent? Prove. 

2. If the dividend of the above stock fell to $37, what would 
you expect the price of the stock to become? 

3. Suppose you are considering the purchase of a $100 gov- 
ernment bond, untaxed and paying 2 per cent interest. What 
price could you reasonably pay, if the rate commonly obtained 
on securities of this grade was 1.9 per cent? Prove. 

4. Here is a piece of farm land which regularly yields a 
net income of $1,700'. What would its price tend to be when 
the rate of interest in such lines was about 5.5 per cent? 

5. Here is a site in a large city which yields a ground rent 
of $51,000 a year. Suppose that the Henry George ideas came 
to prevail in said city, so that the tax on the site named is fixed 
at 93 per cent of its rent. 

(a) What would the price of the site tend to be when the 
rate of interest was about 5 per cent? 

(b) What would it be if the rate of taxation were raised to 
lOO per cent, the rate of interest remaining 5 per cent? 

6. Supposing that there were no interfering causes, what 
would 3^ou expect the price of a government bond bearing 2 
per cent interest to do in times like these (summer 1907) when 
the rate of interest has been exceptionally high for many 
months? 

7. A certain building site regularly yields a net income of 
$300 a year. This fact would cause it to have what market 
value when the rate of interest was 8 per cent? 6 per cent? 
5 per cent? 

8. A certain automobile which is hired out, regularly yields 
its owner a clear income over all expenses of about $300 per 
year. With interest at 6 per cent, this fact would cause the 
car to have what market value? Is this a reasonable problem? 

9. An automobile costs $1,200 and lasts only three years. 
With interest at 6 per cent and with 6 per cent added for the 
trouble and risk of running an automobile livery, what must 
an automobile earn during a year to make the business pay? 

10. A certain building site is worth $22,000. With interest 
at 6 per cent, what surplus over other expenses must any busi- 
ness located on the given site pay in order to make the use of 

206 



CHAPTER IX. NORMAL PRICE. 

the site for that purpose profitable? Is this a legitimate prob- 
lem? 

Section F. Normal Price under Monopoly. 

The preceding discussion of price has been carried forward 
on the assumption that there is free competition among pro- 
ducers or sellers. But the student is of course aware of the 
fact that such free competition is by no means universal. Sub- 
stantially the whole output or stock of not a few kinds of 
goods is in the exclusive control of a single natural or legal 
person. Such a condition of things is known as a monopoly. 
The person having such exclusive control of stock or output is 
said to have a monopoly. That the presence of monopoly would 
tend to alter the conditions determining normal price wuld be 
admitted by every one. Indeed, it is probable that most people 
think of monopoly as doing away with all normality in price. 
The monopolist is often supposed to fix price in a purely arbi- 
trary way. This, however, is going quite too far. Monopoly 
prices, though less submissive to natural laws than competitive 
prices, are not, after all, altogether free from such laws. The 
monopolist is coerced by the conditions of the case into fixing 
his prices so that they conform to certain broad principles. 

In the first place, it is easy to show that the monopolist 
can put prices so high as to make his gains smaller than they 
would have been if he had set his price lower. Thus, suppose 
that petroleum is a monopolized product, and that a section of 
its demand schedule is as follows: 1,900 millions gallons want- 
ed if price is 9 cents ; 2,500 millions if price is 8 cents ; 3,000 
millions if 7 cents ; 4,000' millions if 6 cents ; and so on. Sup- 
pose, further, that the, total cost per gallon is 4 cents, so that 
there is a clear profit of 5 cents per gallon if the selling price is 
9 cents; of 4 cents per gallon if price is 8 cents; and so on. 
If, under these circumstances, the monopolist fixes the price at 
9 cents, he will clear $95,000,000, whereas at 8 cents he would 
have cleared $100,000,000. What he gains through larger profit 
on each unit of product he will more than lose by diminishing 
the total number of units sold. 

On the other hand, it would be foolish for the monopolist 

to go to the opposite extreme in carrying out a policy of lowering 

price in order to increase demand. Thus, if he puts the price 

207 



PRINCIPLES OF ECONOMICS 

down to 7 cents, he will indeed cause demand to increase from 
1,900 millions to 3,000 millions; but the lowering of profit on 
each unit will more than offset this gain in amount sold. His 
net profit will drop to $90,000,000. In short, the self-interest of 
the monopolist will dictate that he fix on the price which in- 
sures that the product of the net profit per unit output into 
total output is the highest possible; and this gives us the gen- 
eral principle determining normal price for cases of strict mo- 
nopoly. 

Principle. Broadly speaking, the normal price of any mo- 
nopolized commodity tends to he that price which will secure 
the largest net return to the monopolist. 

A cursory examination of the preceding analysis of a case 
of monopoly shows plainly that the cause which hindered the 
monopolist from pushing price upward indefinitely was the 
fact that as price rose demand fell off, — in other words, demand 
was elastic, varying inversely as price. If demand had dimin- 
ished more rapidly with increase in price, the price actually 
estab'ished would have been still nearer cost of production. If 
demand had changed less rapidly with increase in price, price 
would have been put still farther above cost of production. 
Hence the following 

Corollary. The tendency of monopoly price to rise above 
the competitive normal varies inversely as the elasticity of the 
demand for the monopolised commodity. 

It obviously follows from this corollary that every cause 
which increases the elasticity of the demand for a given com- 
modity diminishes the tendency of price in said case to separate 
from the competitive normal. Thus, the coming out of a com- 
modity which can be used as a substitute for some monopolized 
one diminishes our dependence on the latter and so makes its 
demand schedule more elastic. 

The preceding discussion of normal price under monopoly 
has brought out the general principle governing this case. But 
it is possible to be a little m'ore specific in the case of one par- 
ticular type of monopoly which has much prominence in our 
day. This is known as the capitalistic monopoly. Such a mo- 
nopoly is one which owes its origin to the control by the monop- 
olist of an exceptional volume of capital. Such a condition 

208 



CHAPTER IX. NORMAL PRICE. 

enables a man or group of men to attain the position of 
monopolist, to gain and maintain exclusive control of output, 
largely because it enables said man or group of men to pro- 
duce more cheaply than rivals and hence drive them out of 
business.^ But it is plain that to succeed, monopolies of this 
sort must keep prices fairly low, — somewhere in the neighbor- 
hood of cost to outsiders; since otherwise competitors will be 
continually starting up, which competitors will have to be bought 
out at considerable cost or driven out by destructive commer- 
cial wars. Formulating this point, we have the following 

Principle. The normal price of goods produced by capital- 
istic monopolists tends to approximate a figure not much above 
cost of production to outsiders. 

Illustrative Problems. 

1. Suppose the demand schedule for Milton's autographs is 
as follows: 1 wanted at $^00; 2 at $175; 4 at $150; 5 at $140; 
8 at $125; 9 at $110; 12 at $100; 13 at $90; 15 at $75; and 20 
at $50. 

(a) If there came on the market 9 autographs, what price 
would they tend to have under free competition? 

(b) What price if all were owned by one man? 

(c) Answer the same questions, supposing the number of 
autographs to be 15, 

(d) Answer the same questions, supposing the number to 
be 20. 

2. When the United States Steel Company was fully organ- 
ized, many independent producers desired the Trust to join 
with them in raising the prices of steel products. The authori- 
ties of the Trust, however, refused, thinking it expedient to 
maintain the old level. What do you suppose was tlie reason? 

3. Suppose that in the "tea" problem, page 190, one of the 
conditions had been a monopoly of the production of this brand 
of tea. What then would the price have tended to be? 

Section G. The Prices of Ultimate Cost Goods. 

In tho preceding discussion of the Normal Price of Pro- 
ducible Commodities, it has been assumed without comment that 
the price of those constituents of cost for which the entrepre- 
neur has to make a money outlay are quantities which he 
finds determined once for all. Starting out to manufacture 
some commodity, he learns that he must pay so much for raw 



^0£ course this is not the whole story. 

209 



PRINCIPLES OF ECONOMICS 

materials, so much for tools and machinery, so much for- labor, 
so much for the use of capital, and so on. In consequence of 
these facts, together with the fact that he has to make certain 
sacrifices peculiar to himself, the product which he puts on the 
market has to have a certain price. Now, this assumption that 
the prices of cost goods are permanently fixed quantities, though 
sufficiently true for many purposes, is plainly untrue as a state- 
ment of the ultimate facts. Some constituents of cost are them- 
selves products, and so, of course, must have prices which vary 
with the prices of other cost goods. Further those constitu- 
ents of cost which are ultimate things, things having no pro- 
ductive process, in the ordinary sense, behind them, e. g., labor 
services, capital services, etc., even these do not have perma- 
nently fixed prices, which can safely be assumed as our starting 
point. The prices paid laborers to work, capitalists to wait, 
and so on are, as every one knows, changing quantities. It fol- 
lows, therefore, that anything like a complete explanation of 
how normal prices are determined must include an explanation 
of how the prices of these ultimate constituents of products — 
ultimate cost goods, let us call them, — are determined; and this 
is our task in the present section. 

We have just said that our present task is to explain how 
the prices of the ultimate cost goods are determined. But here, 
again, we must delay a moment. This way of setting the prob 
lem may easily be quite misleading, in that it may give the 
impression that the prices of the ultimate cost goods are de- 
termined independently of the determination of the values of 
the products derived from those cost goods. Such an under- 
standing of the matter would be very wrong indeed. From the 
demand point of view, the ultimate cost goods are of signifi- 
cance, not at all for their own sakes, but solely for the sake 
of their products. It follows, then, that any influence which 
is exerted upon their value from the demand side must act 
through their products. That is, in part at least, the processes 
whereby the prices of their products are being determined are 
essential elements in the processes whereby the prices of the 
cost goods themselves are being determined. In short, it may 
be said that our present problem is not really a new problem 
at all, but rather our old problem studied in a deeper way. We 

210 



CHAPTER IX. NORMAL PRICE. 

are still trying to find out how the prices of products are/de- 
termined, only we are now looking for the really ultimate solu- 
tion instead of the merely provisional ones with which we have 
thus far contented ourselves. 

In order to make our task reasonably easy, we will start 
with a hypothesis of highly artificial simplicity and by successive 
modifications bring it into something like correspondence with 
the real world. In this opening hypothesis, we will suppose 
(1) that there is but one ultimate cost good — call it L; (2) that 
there is just so much of this good available, no more and no 
less; and (3) that no disutility sacrifice on our part is involved 
in producing or employing this cost good. Under this hypothe- 
sis, every producible commodity would be virtually reducible 
to so many L's. A loaf of bread would be in effect, say, one 
L; a pound of meat, three L's; a hat twenty L's; and so on. 
The final determination of the values of bread, meat, and hats 
would really mean the determination of the value of L's. Since 
by hypothesis, there is no disutility cost involved, the value of 
one L wherever found would have to be in accord with the 
marginal utility of L as embodied in one or more commodities, 
and with that only. The value of any particular product would 
be as many times that of L as there were L's contained in it. 
If there were any products which people did not care to use for 
any purpose in which their utility was as low as that of the 
quantity of L's embodied in them, the value of such products 
would not be affected by their own marginal utility at all, being 
fixed by their cost at a point below their marginal utility. But 
here we should mean by their cost simply the marginal utility of 
the L's entering into them. That is, in such an order of things, 
the principle that cost determines price would be merely the 
chief instrumentality whereby would be secured the complete 
domination of marginal utility. In other words, the cost prin- 
iple would in that case play the same role that the law of single 
price does in causing a non-producible commodity to have a 
price expressing its marginal utility. 

But the hypothesis thus far employed is obviously quite in- 
adequate to represent the facts of life. Let us bring it a step 
nearer by supposing that L's, instead of existing in a fixed 
amount, come into existence through human choice and that 

211 



PRINCIPLES OF ECONOMICS 

their production involves a disutility cost which increases di- 
rectly as the quantity. Will this new element of real cost 
modify the ultimate laws which regulate the value of products? 
The answer depends on what choice we make among three pos- 
sible subordinate modifications of our hypothesis. We may sup- 
pose (1) that our wants are so numerous and our capacities so 
small that our marginal efforts make no appreciable addition to 
output and, so, do not affect marginal utility or value, — we are 
all in the position of producers in our "tea problem"; or (2) 
that our wants are so few and our capacities so great that we 
are able to satisfy absolutely all our wants without anything 
like excessive effort; or (3) that the facts lie between these 
extremes, — we can by no means satisfy all our wants, yet the 
discrepancy between our wants and our capacity is not so great 
but that every additional sacrifice means a substantial contribu- 
tion toward satisfying those wants. Under the first of these 
alternatives, the principle brought out in our first unmodified 
hypothesis would apply : — the value of any product would equal 
the marginal utility of L multiplied by the number of L's en- 
tering into said product. If, however, the second alternative 
represented the facts of life, the principle governing the case 
would be quite the reverse of the one already set forth. Mar- 
ginal utility would play no part in determining value; cost alone 
would be the decisive factor. Every man would have every 
commodity he wanted and would value it at the significance of 
the sacrifice involved in getting it. Finally, if the third alter- 
native represented the facts — if we had to work for everything 
we have and could not at the best attain the satisfaction of all 
our wants, but still every additional sacrifice secured a sub- 
stantial increase in goods — the value of any product would be 
influenced both by marginal utility and marginal cost. That is, 
price would have to express at once the marginal utility of the 
product and the marginal disutility involved in producing it. 

Which now of these three alternatives must we choose for 
our final hypothesis? Which more nearly corresponds to real 
life? While there is some difference of opinion, most econom- 
ists doubtless would decide for the third. The second surely 
can at once be eliminated. If we exclude the half-savage ne- 
groes of some tropical negion, man is far from being so situ- 
ated that he can easily satisfy all his wants. The only question 

212 



I 



CHAPTER IX. NORMAL PRICE. 

remaining, then, is whether the first alternative represents actual 
life. Are we, in respect to goods in general, in the position of 
the producers of the very rare brand of tea? The peculiarity 
of the "tea case" is that wants so greatly exceed productive 
capacity that we find ourselves almost at the outset far down 
in the stage of diminishing returns : — the very small amount 
which we can add to output by greater expenditure has no ap- 
preciable influence on the size of the total and, therefore, does 
not modify marginal utility or price. I cannot believe that this 
pictures the facts of industrial life in general. In most indus- 
tries, surely, the work of "the last hour" has an appreciable ef- 
fect on the volume of output. If it were not performed, mar- 
ginal utility would rise and, so, price would rise. Accordingly, 
we conclude that, if the real world gave us only one ultimate 
cost good the supplying of which involved a disutility, the prin- 
ciple governing value would be that given at the close of the 
preceding paragraph; that is, the prices of products would have 
to be such that the value of the L's entering into them expressed 
at once the marginal utility of L's and the marginal disutility 
of supplying them. 

But our hypothesis still shows one serious difference from 
the reality. Under the hypothesis, there is but one ultimate 
cost good; while the real world has a number which economists 
succeed in reducing to three only through the most heroic pro- 
cess of abstraction Now, this new hypothesis probably does 
not materially increase our difficulties on the cost* side; but it 
presents, on the utility side, a problem which not a few con- 
sider impossible of solution. The case of a single ultimate cost 
good is worked out with comparative ease, because, there being 
but one such good, we can ascertain its significance at any and 
every point, easily and certainly. It takes three L's to produce 
a pound of meat, therefore, L has the significance of one-third 
of a pound of meat. But, when we have several ultimate cost 
goods, how shall we isolate the contribution made by each cost 
good to the joint product? Thus, let us suppose that the use of 

*Thei-e is a special difficulty presented by the fact that one ultimate cost 
good, or one group of such goods, involves no disutility cost while others do 
involve such cost. Can prices be at once influenced by the mere scarcity of 
non-producible elements and by the disutility cost of the producible ones? 
We shall dogmatically assume an affirmative answer, although the matter is 
too subtle for discussion here. 

213 



PRINCIPLES OF ECONOMICS 

a certain amount of land plus a certain amount of capital plus 
a certam amount of labor plus a certain amount of enterprise 
gives us a product having a marginal utility of $75. On the 
basis of this proposition we can properly say that all the constit- 
uents taken together have a marginal utility expressed by $75 ; 
but we can not say anything as to the marginal utility of the 
several constituents taken separately. We seem to be in a posi- 
tion analogous to that of a person who should try to solve an 
equation containing four unknown quantities without other data 
than those supplied by the equation itself: — given v -|-x + y + 
z = $75, to find the values of v, x, y, and z, respectively. Of 
course, such a problem could not be solved. Can ours be? 
Can the several contributions of the different factors in a joint 
process be isolated? If not, then, obviously, the marginal con- 
tribution or significance can not be isolated and therefore can 
not play any part in determining either its own value or the 
values of the goods produced from it. 

The preceding paragraph had brought out a real and great 
difficulty in the way of establishing the theorem that the utilities 
of the ultimate cost goods play a vital part in determining their 
value. This difficulty does not, however, seem to us insuperable ; 
and in this course we shall maintain, on the general point, a 
doctrine which is as nearly as possible the analogue of the one 
which we laid down for our hypothesis of a single ultimate cost 
good involving a disutility cost. Formally stated, it will run as 
follows : — 

Principle. For all consumption products, intermediate pro- 
ducts, and ultimate cost goods, there tends to he established a 
coherent system of prices in which the price of any product 
and the sum of the prices of the cost goods entering into it are 
equal, and in which the, price of any ultimate cost good expresses 
the marginal significance* of said cost goods, as embodied in 
some consumption product, and, at the same time, expresses the 
marginal disutility of supplying said cost good, in case there is 
such a disutility.* 

(More briefly.) The system of prices must be such that the 



*It is hardly necessary to say that no one claims that the marginal utility 
of the ultimate is precisely isolated or precisely expressed in price. All such 
results in economic matters are mere approximations. 

214 



CHAPTER IX. NORMAL PRICE. . 

price of any ultimate cost good expresses at once its marginal 
significance and its marginal disutility, in case it has one. 

Argument: Part I. The first part of the prnciple is im- 
portant but needs comparatively little argument. The system 
of prices must be a coherent whole in which the price of any 
product and the sum of the prices of its costs are equal. Ob- 
viously, this must be true in so far as the prices of cost goods 
determine the prices of products. It surely is not less true in 
other cases. As was indicated in introducing this section, the 
chief reason for not resting satisfied with our previous presenta- 
tion of the cost theories as something final, is the evident fact 
that the prices of products must surely react to inUuence the 
prices of cost goods. Why, in fact, should labor or land be 
worth anything save for the fact that it produces goods which 
are worth something. That is, if in any or all cases the prices 
of cost goods do not determine the prices of products, this is 
because causation works the other way : — the prices of products 
determine those of cost goods. But in that case, obviously, the 
two sets of prices would be equal. In any case, then, the first 
part of our principle is established : — the price of any product 
and the sum of the prices of its costs must be equal. 

Part II. We come, then, to the second part of the prin- 
ciple : — the system of prices must be one in which the price of 
any utimate cost good expresses at once its marginal significance 
and its marginal disutility, if it has one. 

A. That the prices of the ultimate cost good must express 
the marginal significance imputable to them. 

AA. If it be assumed that the marginal utility which can 
properly be credited or imputed to any particular cost good 
can be isolated, the proposition that the price of said cost good 
must tend to express said marginal utility surely needs little 
proof. First, since each of these ultimate cost goods enters 
into almost all classes of economic products, it is substantially 
certain that the utilities which these cost goods contribute, 
when graded in the order of their importance, constitute a vast 
continuous series wherein each utility varies from its nearest 
neighbors by steps so small as to be almost infinitesimal. In 
other words, the demand schedule for one of these ultimate 
cost goods would be an almost ideal one, symmetrical and p^r- 

215 



PRINCIPLES OF ECONOMICS 

fectly graded. Such being the case, price would surely settle 
at marginal utility, whatever the conditions of supply — whether 
the good in question were absolutely limited in amount, or had a 
fixed output, or were producible at will. To convince ourselves 
on this point, we have only to apply the methods used with 
ordinary commodities in the earlier sections of this chapter. 

BB. In the preceding paragraph it was assumed that, if 
we are dealing with a product derived from the union of 
several cost goods, it is possible to isolate that portion of the 
utility of said product which can properly be imputed or cred- 
ited to each of the several cost goods entering into said product. 
This means, for example, that if we had a certain product con- 
taining 13 units of utility which product was derived from the 
joint action of the three cost goods, Ci, C2, and Cs, then in some 
way or other it would be possible to determine with certamty 
that 5 out of the 12 units of utility were imputable to Ci, 3 oth- 
ers to C2, and the remaining 4 to Ca. Now, as already brought 
out a few pages back, this seems on the surface an insoluble 
problem, involving an attempt to solve an equation of three un- 
known quantities with no other equations to help. Neverthe- 
less, most thoughtful people believe that in some way the prob- 
lem is solved, — the contribution of each factor is isolated. This 
is the doctrine taught in the present course. To establish the 
contention is a task of much difficulty as well as importance. I 
will, therefore, pro'ceed in somewhat formal fashion. 

To start with, we must be clear as to the exact nature of 
our problem. And, first, it is not to ascertain the technical con- 
tribution of each factor. For example, when charcoal, sulphur, 
and saltpeter are combined by a Crusoe to make gunpowder, and 
we ask how much does each contribute to the result, we do not 
mean: How necessary is each chemically? for, of course, each, 
in being necessary at all, is as necessary as every other. 

In contrast the problem is to ascertain the economic contri- 
bution of each factor, — its significance economically considered. 
Thus, suppose Crusoe's stocks of charcoal and sulphur unlimited, 
but that of saltpeter so small that he must restrict quite carefully 
^ts use in making powder, — -keeping his output of the latter at a 
figure which makes the marginal utility and value of one pound 
j.ust 90 cents. Supposing his labor negligible, what utility or 

216 



CHAPTER IX. NORMAL PRICE. 

value will he impute respectively to the charcoal, the sulphur, 
and the saltpeter necessary to produce a pound of powder? 
Answer : to charcoal, zero utility or value ; to sulphur, zero util- 
ity or value ; to saltpeter 90 cents of utility or value. He will 
set as much store by every .76 of a pound of saltpeter as by 
1 pound of powder; because having the powder depends on hav- 
ing that .76 of a pound of saltpeter. He will not set any store 
b)'' every .11 of a pound of charcoal or .IS' of a pound of sul- 
phur, because having particular portions of either of these is not 
at all necessary to having the powder. Chemically, the powder, — 
under the hypothesis laid down, — is produced out of the char- 
coal, sulphur, and saltpeter put into it. Economically, it is pro- 
duced from saltpeter only. 

Going on, now, to show that this problem is actually solved 
in real life, we will lay down a thesis embodying our theory of 
how this is done. 

Thesis: — While entrepreneurs are unable to ascertain in ad- 
vance of the determination of wages, interest, etc., the real con- 
tribution properly imputable to each element in production, yet 
the spontaneous working of economic forces tends automatically 
to secure to each element that price — wages, interest, etc. — which 
expresses its contribution to the product. 

(I.) First Stage in the Demonstration. 

Proposition: — Even if we suppose that the ultimate productive 
elements are used only in combination, so long as they are used 
in different combining ratios, each has just one particular degree 
of importance attaching to it in view of the several parts which 
it plays; and this would be true though we were quite unable to 
ascertain that degree of importance and though it had no influ- 
ence on the price paid for the element in question. 

To simplify the process, we will set out with the following 
hypothesis: — All products are made out of just three ultimate 
elements combined in different proportions for different products ; 
the combining proportion for each product is fixed; our stock of 
the ultimate elements is rigidly fixed and so limited that, though 
we can derive from it a number of different products, yet we 
shall have to go without many other desirable ones. 

Argument: — (A.) Under the conditions stated our entire 
stock of elements should be devoted to producing certain com- 

217 



PRINCIPLES OF ECONOMICS 

modifies rather than others. Only by this procedure could we 
get the largest possible quantity of satisfactions from the stock 
of elements at our disposal. (B.) As used in making the 
particular products which most completely utilize our resources, 
each of the ultimate elements has its own peculiar significance, 
value. To bring this out, let us make a symbolical representation 
of this sort of a case out of our powder illustration. Let us 
suppose that the three ultimate elements are charcoal, sulphur, 
and nitre ; that our stock of each is scarce and when best utilized 
is devoted to the production of three commodities, Pi, P2 and Pa, 
worth respectively 62 cents, 34 cents, and 31 cents ; that the com- 
bining proportions are represented in the following equations ; 
and that the cost of our products in labor or other sacrifices 
is negligible, 

3 oz. C+ 2 oz. S+11 oz. N=16 oz. Pi=62 cents value. 

4 oz. C+10 oz. S+ 2 oz. N=16 oz. P2^=34 cents value. 
10 oz. C+ 3 oz. S+ 3 oz. N=16 oz. Ps^Sl cents value. 

An algebraic solution of these equations shows at once that 
the real value or significance of charcoal, taken by the ounce, 
is expressed by 1 cent, that of sulphur by 2 cents, and that of 
nitre by 5 cents. With our limitations we might be unable to 
ascertain these facts ; but facts they certainly are. 

(II.) Second Stage in the Demonstration. 

Proposition. -If at any time the actual prices set upon the ulti- 
mate productive elements fail to express the true significance of 
those elements, this fact will itself set up reactions which wil\ 
tend to bring each of said prices to a point where it does express 
said true significance. 

Hypothesis : — As before. 

Assumption : — Supposing certain prices — whether right or 
wrong — for the ultimate elements and their products to be 
already in existence, entrepreneurs have no difficulty ascertaining 
what goods they can most profitably produce, so long as those 
prices prevail ; and the natural working of the usual economic 
forces will insure that entrepreneurs will leave the less profitable 
for the most profitable industries. 

Argument. For the sake of simplicity, we will follow the 
same symbolic procedure as before, starting with our original 
equations : 

218 



■ \^ CHAPTER IX. NORMAL PRICE. 

3 C + 2 S + 11 N = 16 Pi = 62 cents. 

4 C + 10 S + 2 N = 16 P2 = 34 cents. 
10 C + 3. S + 3 N = 16 Ps = 31 cents. 

Under these conditions, as already noted, the true values of 
C, Sj and A^, must be 1, 2, and 5 cents respectively. Will these 
be realized in practice? Can any others stand? Surely not. 
Thus, let us suppose that at some particular time actual prices 
were different, say 4 cents for C, 3 for S, and 1 for N. What 
would happen? First, the conditions named would lead entre- 
preneurs to discontinue producing P2 and P3 and to devote their 
entire resources to producing Pi; for, with the prices named. 
Pi would show a special profit of 33 cents per ounce, while P2 
and P3 would show losses of 14 and 21 cents, respectively. But, 
secondly, concentrating all production on Pi would throw several 
units of C and 6' out of use altogether, since fewer of them are 
needed in Pi than in P2 and P3. This will of course lower their 
prices. At the same time, the great profits obtainable in pro- 
ducing Pi will intensify the demand for N and so raise its price. 
Finally, the cessation of production in the cases of P2 and Pa 
will cause the prices of these to rise until they are high enough 
to draw back elements needed in their production from the 
producing of Pi. But, since C, and vS' are already superabundant, 
this drawing back from Pi will fall chiefly on A^, i. e., the de- 
mand for it will become excessive and so the already existing 
tendency of its price to rise will be increased. That is, various 
reactions will have been set up tending to lower the prices of 
C and S, which by hypothesis are too high, and to raise the price 
of N, which by hypothesis is too low. Thus the very existence 
of discrepancies between the actual prices of C, S, and A^ and 
the prices which express their true significance sets up reactions 
which tend to remove those discrepancies. 

(III.) Third Stage in the Demonstration. 

Thus far we have been working on the hypothesis that our 
cost goods are absolutely limited in amount. Our argument 
up to this point, therefore, will cover the case of such ultimate 
cost goods as have this characteristic, and so completes the 
demonstration for Case 1. For the second class of ultimate 
cost goods, however, the matter is not yet quite cleared up. 
These goods are not fixed in output. The quantity supplied 

219 



PRINCIPLES OF ECONOMICS 

can and does change. However, this difficulty is not serious. 
In any given case, the output is for the time being determinate. 
Under the working of the processes already described, the tem- 
porarily determinate output will have its price fixed at a point 
which expresses its marginal utility. Now, the only way in 
which the price thus fixed could be disturbed is through a ma- 
terial change in the output of the goods in question. Such a 
change we have assumed to be possible and that in response to 
economic motives. This could be only on condition that the 
price temporarily reached was above or below the marginal 
disutility of supplying said cost goods. Let us suppose it to be 
above. In that case, the output of said goods would be increased. 
But this would merely mean a new temporarily-fixed stock, the 
price of which would quickly come to coincide with its mar- 
ginal utility under the working of the processes already out- 
lined. Should this new price still prove too high, the operation 
would be repeated, and so on indefinitely until full equilibrium 
had been reached and that with a price which coincided with 
marginal utility or contribution. 

The above reasoning assumes that the provisionally deter- 
mined price, while coinciding with marginal contribution, was 
above marginal disutility. It, therefore, leaves the alternative 
hypothesis of a price below marginal disutility still to dispose 
of. This, however, offers no difficulty. Reasoning exactly anal- 
ogous to that employed would show that final equilibrium among 
the price-making forces could be reached only when price had 
come to coincide with marginal contribution as before. 

B. We have argued for the contention that the prices of the 
ultimate cost goods must tend to be such as will express their 
marginal significance or utility. We have still to maintain the 
contention* that, if the ultimate cost goods in question depend 
for their existence on human choice, their price tends to be 
one which expresses not only their marginal utility, but also the 
marginal disutility involved in supplying them. 

That the prices in question actually will tend to express the 
marginal disutilities involved, in the sense that the disutilities 



*This doctrine seems to us the sound one; and I think it is the 
opinion of the majority of economists. It is, however, much less irn;portant 
than the point with reference to marginal utility, and will be argued mucn 
less elaborately. . , 

220 



CHAPTER IX. NORMAL PRICE. 

and the price will tend to coincide, probably every one will 
admit. Even if price were entirely determined by marginal 
utility it would tend to coincide with marginal disutility, since 
the latter would proceed to adjust itself to said price. 

But this sort of coincidence between price and disutility is 
not the one claimed in our principle. It is there meant that price 
must express marginal disutility in the sense that said marginal 
disutility has a real share in -fixing price just as truly as has 
marginal utility. This means that marginal disutility plays 
some part both in keeping price as high as it is and in keeping 
it as low as it is. The difference between such a case and that 
of a fixed-supply or fixed-output good in which latter case the 
coincidence of price and cost are effected by the mere adjust- 
ment of cost to price is best seen by comparing the case of the 
special brand of tea with that of silver as represented on page 
198. In the former, a rise of two steps in the demand schedule 
causes a two-step rise in price ; and, so, a fall of two steps in 
demand causes a two-step fall in price. But with silver, a 
two-step rise in the demand schedule, causes only a one-step 
rise in price — the larger rise being shut out by increased produc- 
tion. So, a two-step fall in demand causes only a one-step fall 
in price, — the larger fall being shut out by diminished pro- 
duction. 

This illustration brings out the real crux of the matter, 
Whether or not disutility has any real share in determining price 
in the cases before us turns on whether changes in price cause 
changes in output sufficiently great to alter price. Does the 
failure of the rate of interest to be high enough to express the 
capitalist's estimate of the disutility of supplying it cause accumu- 
lation to fall off till the rate rises? On the other hand, does 
the fact that the rate of interest has remained some time above 
a rate which expresses the capitalist's estimate of the disutility 
cause accumulation to increase till the rate falls? If these 
questions must be answered in the affirmative, then in the case 
of one ultimate cost good — waiting power — disutility certainly 
plays a part in price-determination. The question is probably 
one which can never receive a decisive answer ; but at present 
most persons would answer it affirmatively. 

What now, is to be said with respect to the other most 

221 



PRINCIPLES OF ECONOMICS 

important cases of ultimate cost goods the existence of which 
depends on human choice, viz., most types of. labor service? 
Here the test is the same as before. Do changes in wages 
sufficiently influence the supply of labor services to cause a 
reaction which alters those wages? Here it would be necessary 
to distinguish a short-time and a long-time normal. Some, 
certainly, would be disposed to affirm that for periods of mod- 
erate length, the supply of labor services, particularly those of 
the most common type, are substantially fixed, — about so many 
days of labor will be offered whatever the rate of wages. If a 
price of $2 per day can be had, well and good; but if it turns 
out to be only $1.50, we must make the best of it. I am not 
entirely satisfied that this is true. I am disposed to believe 
that even for periods of moderate length enough laborers can, 
and often do, refuse to accept a wage which is below their esti- 
mate of the disutility involved in supplying the labor to cause 
a rise in wages or at least to check a fall. However, I will not 
press the matter, and surely would not claim that this is always 
the way things work. 

As respects the long-time normal for wages, the case for our 
principle is more easily made and more commonly secures a 
verdict. In fact, the great majority of economists accept more 
or less fully the doctrine that in the long run, under the work- 
ing of the principles of population, the wages of common labor 
are kept at a point which expresses, roughly anyhow, the stand- 
ard generally accepted by the class interested as to what a 
laborer's income must be to make his life worth while. If wages 
are below this figure, marriages are postponed, or in other ways 
population is restricted, thus diminishing the supply of labor 
power and so causing a rise in wages. If wages are above the 
disutility minimum, an exactly opposite movement takes place, 
the supply of labor-power increases and the price of labor falls. 

In the last paragraph, it was pointed out that economists 
generally recognize that in the case of common labor, anyhow, 
the working class conception of the disutility cost of labor 
plays a part in fixing the long-run normal of wages. This seems 
far more certainly true in the case of the higher forms of labor. 
In these forms the workers always have as a last resort the 
alternative of dropping into a lower calling. The result is that 

222 



CHAPTER IX. NORMAL PRICE. 

each of the higher callings gradually develops a standard which 
is conceived as necessary by those who join its ranks. If for a 
time that standard is passed, then a more than usually rapid 
inflow of recruits from the oncoming generation makes supply 
excessive and causes a fall in the remuneration. On the other 
hand, if for a time the standard is not reached, recruiting falls 
off and the remuneration has to rise. 

Illustrative Problems. 

1. Some writers are accustomed to speak as if the value of 
each particular kind of goods were determined by its own mar- 
ginal utility solely. 

Show that, even if it be admitted that utility is, ultimately 
speaking, the only cause affecting values, the position alluded to 
is after all quite untenable. 

2. Some writers more cautious than the last are accustomed 
to speak as if the value of every particular kind of cost goods, 
e. g., iron, copper, lumber, etc., were determined by the marginal 
utility of the marginal commodity produced from it, without 
regard to anything else. 

Show that this position also is quite untenable, though it be 
admitted, as before, that the sole ultimate cause influencing 
value is utility. 

3. Some writers are accustomed to speak as if the value of 
every particular durable commodity were determined entirely by 
capitalizing its own income of money or services. 

(^a) Show that this is quite untenable. 

(b) Show that it would still be untenable if we were to 
substitute for "its own income" "the income of the marginal 
member of its class." 

(c) Make an extreme hypothesis under which it might be 
maintained that there was not a single case of a durable pro- 
duced good in which the value of said good was what it was 
because the income was what it was. 

4. An eminent American economist who formally rejects the 
doctrine that the values of the ultimate cost goods, labor, wait- 
ing, etc., are determined by their productivity, nevertheless ex- 
presses the opinion that "interest is determined proximately by 
the increase of product resulting from the last or marginal 
application of capital." 

Are the two opinions consistent? 

Section H. The Labor Theory of Value. 

The student is of course aware that one of the most vig- 
orous of the revolutionary or reform agitations of our day 
has for its object the establishment of an economic order known 

223 



PRINCIPLES OF ECONOMICS 

as Socialism, — meaning thereby an order in which economic co- 
operation should not be spontaneous as today but rather should 
be formal, conscious, organized,^ — an order in which the state 
should be the sole entrepeneur, as also the sole capitalist and 
landlord. Now this socialism is in essence merely a system of 
economic organization, not a body of economic doctrines. 
Further, one can with entire consistency advocate this social- 
istic order without holding any peculiar economic doctrines. 
Still, as a matter of fact, one or more peculiar economic doc- 
trines have played a very great part in securing the acceptance 
of socialistic ideas. Indeed, without those doctrines, it seems 
almost certain that the scheme would have gained few converts. 
For the strength of the agitation has been its denunciation of 
the present order as grossly unjust, as one in which the real 
producers of wealth have been robbed almost completely by 
hordes of parasites in the shape of middlemen, capitalists, land- 
owners, et alteri. Now, the chief theoretic basis of this con^ 
tention as actually argued has been a particular theory of value 
together with a theory of profits which may be looked on as 
little more than a corollary from said theory of value. This 
theory of value is known as the labor theory. It teaches that 
the ratio in which goods exchange is determined entirely by 
the ratio between their labor costs, — is in fact the reciprocal 
of the ratio between their labor costs. Thus, if a certain table 
costs 5 days' labor while 25.8 grains of gold costs a half day's 
labor, i. e., if the ratio of their labor costs is as 5 to ^ or 10 to 
1, then their exchange ratio will be 1 to 10, i. e., 1 table will be 
worth 10 times 25.8 grains of gold, or, if we call the latter one 
dollar will be worth 10 dollars. 

This illustration is particularly useful in that it enables us to 
make Marx's way of teaching this labor doctrine stand out 
with peculiar distinctness. A dollar's worth of gold costs one- 
half day's labor, or two dollars' worth costs a whole day. Hence 
a day's labor will put into any product whatsoever two dollars 
of value. 

In interpreting this theory of Marx, the student must guard 
against supposing that Marx makes the value of a thing to 
depend on current labor alone. For example, if a man takes 
100 feet of lumber, a pound of nails, etc., and in one day makes 

224 



CHAPTER IX. NORMAL PRICE. 

a shed, Marx would not say that the shed will be worth just $2, 
It is, of course, necessary to include also the labor spent pro- 
ducing the lumber, the nails, etc., — past labor. Goods of this sort 
are commonly called capital, and Marx so designates them and 
characterizes them as congealed labor. It is thus evident that 
Marx recognizes the fact that capital helps to determine values, 
only it is capital viewed as the embodiment of past labor. 

But perhaps the student will now wonder how Marx's view 
differs from that of other people. The answer is that, while 
Marx admits the influence of capital, he does not admit the 
influence of the waiting or other sacrifice involved in supplying 
capital. Thus, if the lumber, nails, etc., in the above example 
had cost the labor of one day and a half, Marx would say that 
the value of the shed must be $5, i. e., $S' for the materials — 
congealed labor — and $2 for the labor; whereas every one knows 
that the materials would have cost something more, perhaps $4, 
because of the waiting and other sacrifices involved in supplying 
such capital goods. 

As a clear understanding of Marx' doctrine is necessary to 
its refutation, we will mtroduce here some illustrative problems. 

Illustrative Problems. 

1. Suppose a certain stove costs 10 days' labor and a certain 
watch costs 30 days'. At what rate will they exchange? 

2. Suppose that 10 pounds of raw colton are produced in 2 
days, that 61.38 grains of gold are produced in the same time, and 
that the law defines a pound sterling as being 123.27 grains of 
gold. How many shillings (there are 20 in the pound) should 
10 pounds of raw cotton be worth? 

3. Suppose that it costs a half day's labor to produce the 
goods commonly considered necessary to support a laborer and 
his family for a day, that the goods necessary for this purpose 
actually constitute a day's wages, that one-half day's labor will 
produce 25.8 grains of gold, and that the law makes 25.8 grains 
of gold the standard fixing the value of one dollar. What would 
naturally be the money wages per day? 

4. Starting with the last problem, suppose that a laborer 
working for a whole day should produce for his employer, out 
of raw cotton costing 50 cents, a certain quantity of cotton 
yarn. 

(a) How much ought the yarn to be worth? 

(b) How much profit per day would the employer naturally 
make out of the transaction? 

225 



PRINCIPLES OF ECONOMICS 

5. "The notion of Marx and the socialists generally that the 
value of a pair of shoes depends merely on the amount of labor 
expended on them by the cobbler without respect to the cost of 
the leather in them, is too ridiculous for serious consideration." 

Show that such language involves an entire misapprehension 
of Marx. 

Refutation of the Labor Theory — ^Reading 24. 

A. In the first place, as already fully brought out, there are 
not a few goods which have their value determined with no 
reference to cost of any sort, labor cost or waiting cost or risk 
cost. In this class belong all rare unproducible objects, those 
producible objects whose possible output is far short of de- 
mand at prices much above the corresponding costs, and, most 
of all, the uses of land. In all these cases marginal utility is of 
course the decisive factor in value determination. 

B. In the second place, ordinary producible goods, though 
having their values determined by cost (expense), yet have 
them so determined hy a cost which includes other things besides 
labor, notably waiting and risk. A commodity which costs one 
day's labor and ten years' waiting surely must and does sell for 
more than another commodity which costs the same amount of 
labor but only one year of waiting. 

It would seem that this second point is too plain to need 
elaboration. Still, as the matter is of great practical moment, 
I am disposed to make assurance doubly sure by making this 
point in the way which has led some of the most prominent 
socialists to relinquish the doctrine. 

(1) In the production of any commodity, there appear two 
kinds of labor, previous labor spent on raw materials, tools, etc., 
and current labor using these materials, tools, etc. ; — congealed, 
stored up, labor and current labor. In the outlay of the entre- 
preneur, these two sorts of labor appear as two kinds of capital 
invested in them, viz., cofistant capital — what is paid for ma- 
terials, tools, etc. — and variable capital — paid for labor-power. 

(2) If the labor theory of value were true, the entrepreneur 
could get a profit on his variable capital, but on that only, (a) 
He could not get a profit from the constant capital, since he 
buys it directly at the market price, and its value, being deter- 
mined by its labor cost, will be just the same to him as a buyer 
as it will be to him when he becomes a seller. To illustrate, 

226 



CHAPTER IX. NORMAL PRICE. 

suppose that Mr, A is engaged in producing a commodity which 
costs three days' labor, two of previous labor spent on raw 
materials, etc., and one of current labor; and suppose that a day's 
labor will produce 51.6 grains of gold, i. e., $2 of value. Then, 
the value of the completed commodity will, of course, be $6, 
since it costs three days' labor. Further, it is obvious that of 
this value two-thirds, $4, must be credited to the previous labor 
(the congealed labor, the constant capital), since the latter is 
two-thirds of the whole labor. But the market value of this 
congealed labor (materials, etc.), must have been $4, being 
determined by a labor cost of two days. It must, therefore, 
cost Mr. A $4. Thus he puts into constant capital $4 and gets 
out of it $4. His constant capital, therefore, yields no profit. 

(b) Mr. A could, however , get a profit out of his variable 
capital, i. e., the portion spent on current labor. For, while the 
value said labor adds to the raw materials, etc., is $2, its own 
purchase price, the price Mr. A has to pay for it, is something 
different, being determined by its labor cost, or rather the labor 
cost of the power to furnish it, i. e., the labor necessary to pro- 
duce the subsistence of the laborer. If we suppose this to be 
one-half a day, then the entrepreneur will be able to buy labor 
(labor power) for $1, and then get out of it a whole day's labor, 
and therefore get out of it value to the amount of $2. Thus, 
from a total expenditure of $5, he gets a commodity which 
sells for $6, and so reahzes a profit of $1. But this dollar, it is 
plain, was entirely derived from his variable capital, the constant 
portion having yielded nothing. 

(3) It is, however, quite impossible that a condition of things 
which secures a large return to variable capital and no return 
to constant capital should continue. In the case above considered, 
Mr. A gets 20 per cent on his investment. If he had been en- 
gaged in an industry requiring one unit of previous labor to 
two units of constant labor, these would have cost him $4, mak- 
ing his profit $2 or 50 per cent. If the three days of labor had 
been one-half day of previous labor and two and one-half days 
of current, then their cost would have been $3.50, making his 
profit $2.50 or 70+ per cent. On the other hand, had the three 
days' labor been divided into two and one-half days of past 
and one-half day of current labor, their cost would have been 
$5.50, leaving him a profit of only 50 cents or 9 per cent. 

227 



PRINCIPLES OF ECONOMICS 

.'. Manifestly such a state of things could not continue. Capi- 
talists would all flock to the industries returning high rates, — 
those using much current labor, i. e., much variable capital. As 
a result, prices in these industries would fall ; while, in those 
using little current labor, i. e., little variable capital, prices 
would rise. In a word, prices would in the one case be lower 
than labor cost would have made them, and in the other case 
would be higher. That is, exchange values would not be deter- 
mined by labor, 

. Note 1, Some economists, more generous than accurate, 
have declared that Marx, the socialist who is considered most 
responsible for the doctrine, did not mean that values are deter- 
mined by labor cost, but merely that they ought to be so deter- 
mined. This entirely misses the point of what is styled "Scien- 
tific Socialism." That socialism claims to discuss the facts and 
natural laws of the present order, and to show that the unhin- 
dered working of those laws brings about certain undesirable 
results. Its whole argument is pointless save on the assumption 
that it is dealing with actual principles. If values are not here 
and now determined by labor cost, the whole proof that capital 
gets a surplus actually produced by labor falls to the ground. 

: Further, such an interpretation of Marx must ignore his own 
explicit statements. Thus, he says : "We see, then, that that 
which determines the magnitude of the value of any article is 
•the amount of labor socially necessary, or the labor time socially 
necessary for its production." Chap. I, Sect. 11 ; or again : "The 
price, then, is merely the money-name of the quantity of social 
labor realized in his commodity." Chap. Ill, Sect. 2; or again: 
"We know that the value of each commodity is determined by the 
quantity of labor expended on and materialized in it by the 
working-time necessary, under given social conditions, for its 
production." Chap. VII, Sect. 2. 

Still further to refute this notion that socialists do not really 
teach the labor theory, we have the fact that the most recent 
expositions of their ideas contain the old doctrine. Thus in 1906 
John Spargo, a prominent socialist lecturer, wrote a book on 
socialism in which we find these words : "The exchange value 
of commodities is determined by the amount of average labor at 
the time socially necessary for their production." p. 196. Further, 
Spargo quotes with hearty endorsement a two-page exposition 
of Marx's Surplus Value theory of profits by another socialist, 
Algernon Lee, in which exposition the labor theory of value is 
made to play the same role as in the original presentation by 
Marx. 

.^ ^Tote 2. The student must not imagine that socialism as a 
project of reform stands or falls with the labor theory of value. 

228 



CHAPTER IX. NORMAL PRICE. 

The movement has not a few able advocates who frankly re- 
pudiate the Marxian economics. Socialism is essentially a scheme 
of social organization for economic ends. As such a scheme, it 
deserves to be considered on its own merits, without respect .to 
the entirely untenable doctrines with respect to the present order 
which its advocates have commonly held. Nevertheless, there 
can be no doubt that the general rejection of Marxian eco- 
nomics, which must surely come, will weaken the socialist move- 
ment. For, as already noted, the strength of the movement has 
depended, in large measure, on grossly exaggerated statements 
as to the unreasonableness and injustice of the present order, 
and these statements have been founded on the labor theory of 
value. 

Section I. Miscellaneous Problems in Price. 
1. There come on the market eleven specimens of a certain 
rare object to be disposed of at the best price attainable. If the 
demand is as follows: 1 wanted at $65; 2 more at $60; 4 more 
at $50; 5 more at $45; 6 more at $40; etc., what price will tend to 
be reached? Prove. 

2. In the last problem, suppose a tax of $5 to be levied on 
each specimen sold. 

(a) What effect on price would be produced? 

(b) Who would bear the tax in the end? 

3. In stating the principle that the prices of goods tend t& 
equal their money cost of production, some writers prefer to say 
"cost of reproduction." 

(a) Why do you suppose they have this preference? 

(b) Show that, on the assumption implied in the very idea 
of normal price, the change from "cost of production" to "cost 
of reproduction" is at least unnecessary. 

4. There are in a certain city 11 business sites of a certain 
grade, each of which could be used for a variety of purposes, 
and would give off a different yearly income according to the 
particular use to which it was put. The schedule for these dif- 
ferent possible uses is as follows : 1 giving a net income of 
$7,000; 5 others giving a net income of $6,000 each; 2 giving 
$5,000 each ; 4 giving $4,000 each ; 2 giving $3,000 each ; 2 giving 
$2,000 each ; and 3 giving $1,000 each. 

(a) What will the rent of one of these sites tend to be? 
Prove. 

(b) What would the rent tend to be if the sites were all 
owned by one man? Prove. 

229 



PRINCIPLES OF ECONOMICS 

5. "Every owner of a railroad, of a patent, of a book, or of 
a (monopoly) property of any kind, finds that he makes more 
money by putting prices down to figures that are reasonable, 
that is, to figures which correspond to the values to the buyers 
of the things sold, than by keeping them up beyond those 
figures." — Stickney. 

(a) Show that the words "which correspond to the values 
to the buyers of the things sold," are useless as a definition of 
"reasonable" prices. (Name some object which has a price 
greater than that one which would express the value of the 
object to buyers.) 

(b) In the case of producible goods, what price is commonly 
considered a reasonable one? 

(c) When "reasonable" is understood this way, is it probable 
that the first half of Stickney's statement is true? 

(d) Point out some cases of monopoly of which the state- 
ment can be affirmed with a fair degree of accuracy. 

6. In answering Problem 4, students frequently said : "The 
rent will be $1,000, because $i,ooo expreses the marginal utility 
cf the sites." Criticise the part in italics. 

7. In Problem 4 (b), many said that the rent would tend to 
be somewhere between $4,000 and $5,000, perhaps $4,500. Show 
that, with the use schedule given, this could not be. Defend 
the statement that the rent would tend to remain for a time 
something above $4,000, finally settling at $4,000. 

8. "When the demand for wheat increases so as to exceed 
the capacity of the best land, the price of wheat rises so as to 
leave an excess or surplus over cost of production, and this sur- 
plus is driven into the hands of the landowner as rent by the 
natural competition of tenants. But, now, the high price of 
wheat leads to the cultivation of inferior soils, which increases 
the supply of wheat so as to satisfy the demand, and thus brings 
the price of wheat hack to its old place" Criticise the part in 
italics. 

9. "Alone and lost in the desert, his last morsel of food and 
his last drop of water gone, he would cheerfully have given his 
gold, his yachts, his palaces, all his wealth, for the meager fare 
of the day laborer. At last the illusions which he shared with 

230 



CHAPTER IX. NORMAL PRICE. 

civilized society were fully dispelled. The unutterable folly of 
the comparative estimates which men commonly put on things 
became manifest. At last, on the verge of oblivion, he saw 
things in their true, their real, proportions." Criticise. 

10. The table given below contains a section from a hypothet- 
ical output schedule for silver and the corresponding sections 
from five different demand schedules. To save space, the cost 
column from the output schedule and the utility column from 
the demand schedule are printed together. On the basis of this 
table, answer the following questions : 

(a) What would the price tend to be for each of the five 
demand schedules? Prove. 

(b) Which of the two chief determinants of normal price is 
decisive in each of the five cases? Why do you think so? 



UTPU' 


r COST (or) 






DEMAND 




il. oz. 


UTILITY 






mil. oz. 










SCH. A 


SCH. B 


SCH. c 


SCH. D 


SCH. E 


290 


59 cents 


185 


190 


205 


217 


205 


290 


58 " 


190 


203 


218 


250 


218 


290 


57 " 


200 


218 


230 


248 


230 


260 


56 " 


209 


230 


245 


260 


245 


260 


55 " 


225 


240 


258 


275 


275 


198 


54 " 


230 


255 


270 


290 


290 


175 


53 " 


239 


275 


290 


315 


315 


175 


53 " 


246 


290 


310 


3S'0 


330 



(c) Notice that Schedule E gives us a very unstable case. 
Price tends to rest finally at one point; but is liable at any time 
to be temporarily moved from that point. Explain (1) why 
price tends to rest where it does and (2) why its hold on that 
place is insecure. 

11. A railway lawyer is trying to prove before a court that 
a proposed 2 cents per mile passenger rate is unjust to his road 
in that it will not permit paying a reasonable profit, say 6 per 
cent, on the investment. He admits that this rate will be realized 
on the physical equipment of the road, valued at $5,000,000; but 
argues that the company has to provide for a pay roll of $50,000 
every month and ought to earn profits on this as well. Now 
this claim may or may not be reasonable. It all turns on 

231 



PRINCIPLES OF ECONOMICS 

whether providing for this pay roll involves, etc. Finish the 
sentence. 

12. The table given below contains a section from a hypo- 
thetical demand schedule for a certain producible commodity and 
the corresponding sections from four different output schedules. 
What prices might be fixed under each of the output schedules? 
Give the argument in each case. 

OUTPUT UTILITY DEMAND 

(or) COST 

SCH. A SCH. B SCH. C SCH. D 

15 15 15 15 $52 ■ 9 

12 12 15 15 51 9 

12 12 15 15 50 12 

12 12 12 12 49 12 

12 12 12 12 48 12 

12 12 12 12 47 12 

12 12 12 12 46 12 

9 12 9 12 45 13 

9 12 9 12 44 15 

9 12 9 12 43 15 

9 9 9 9 42 15 

9 9 9 9 41 15 

13, "A friend of mine owns in a Chicago suburb a house and 
lot which used to rent for $300 a year. Last year real estate in 
his neighborhood had a boom, with the result that his property 
increased in value $3,000. In consequence he raised the rent to 
$480." What is the matter with the economic doctrine involved? 

15. "There is a good deal of nonsense said about the power 
to rob the public possessed by a company which furnishes a 
public utility. The company can get no more than the public is 
willing to pay. If the public think the price too high, they will 
not pay it; and the company will be forced to put the price at 
what the public is convinced is a fair price." 

(a) What is a fair price as generally understood by the 
public ? 

(b) Is there good reason to expect that the companies who 
furnish public utilities will sell them for fair prices, in the 
absence of special contract or government control? Why? 

16. A certain man improves the opportunity offered by a 

232 



CHAPTER IX. NORMAL PRICE. 

growing city of 40,000 inhabitants to develop a messenger service 
business, from which at the end of three years he finds himself 
getting a net return, after allowing himself wages for manage- 
ment, of $700. The capital invested, which includes a bank 
balance of $200 which he commonly maintains, is only $500; but 
he has to provide for a pay roll of about $200 a month or $2,400 
a year. He now tries to sell out the business, asking for it 
$8,750. Assuming that the good will of the business is worth 
$500, and that 8 per cent is a reasonable rate of interest and 
profit, is the price proposed a reasonable one? Does the size of 
the pay roll make any difference? Explain. 

17. The utilities of a bushel of wheat vary by one-cent 
differences, the costs by 5-cent differences (being 25c, 30c, 35c, 
etc.). When marginal utility has reached o'5c or more but not 
40c, what prices may prevail? What determines price under 
these conditions? 

18. "If the state should inaugurate the policy of levying on 
the livery business a 10-per-cent income tax, the value of all 
plants devoted to this business would necessarily fall off 10 per 
cent." Criticise. 

19. "Analogous arguments, * * * might be made with regard 
to municipal railways, lighting companies, and water companies. 
These are all, for one cause or another, of a monopolistic char- 
acter. The public enjoys no guarantee of fair treatment on 
account of any competition that can affect them." Adams' 
Finance, p. 264. 

What is the doctrine with respect to competitive industries 
which is implied in the last sentence of the quotation? 



2:i3 



CHAPTER X. 

SOME OF THE MORE IMPORTANT PRINCIPLES 
GOVERNING MONEY. 

Thus far we have done nothing with the complicated and 
difficult subject of money except to set forth in Chapter VII some 
simple truths which seem almost too obvious to deserve formal 
statement. Now, however, we have reached a point where it 
seems necessary and proper to present the more essential among 
the real principles of the subject, though even now anything like 
an exhaustive study of this matter is out of the question. 

Section A. — Principles Governing the Money Standard. 

The student will remember that the monetary standard is that 
something which fixes the significance or value of the money 
unit; e. g., in the United States 25.8 grains of gold, nine-tenths 
fine, fixes, regulates, the value of the dollar. Whatever value 
25.8 grains of gold may have at any time, that same value will be 
had by one dollar. This account of the monetary standard very 
plainly shows that it is in a very important sense the foundation 
of the whole system. Further, experience shows that it is by no 
means easy for a nation to get or keep the standard it wishes to. 
Again and again nations have unintentionally done something 
which ousted the standard they had had, and suddenly put them 
on a new one. It is therefore of much importance to know 
the natural laws which regulate the standard. 

These principles may be grouped in two classes: (1) those 

which define and determine standard money; i. e., the immediate 

standard, the something which directly fixes the value of the 

unit, and (2) those which define and determine the ultimate 

standard; i. e., the something which finally fixes the value of 

standard money itself. Thus, gold coin is our standard money, 

since one dollar — the unit — follows gold coin; but 25.8 grains of 

gold bullion is our ultimate standard, in that gold coin itself 

follows this 25.8 grains of gold bullion. 

234 



CHAPTER X. PRINCIPLES OF MONEY. 

Principle 1. The standard money of any system must he a 
money which is at par and which has its value -fixed independently 
of its relations to other moneys. 

Argument. (1) Standard money must be at par. By defini- 
tion, standard money immediately fixes the value of the unit. 
But, obviously, no money which has a value above or below the 
unit can Hx the value of the unit. (2) If a particular money 
has its value fixed by its relation to some other, e. g., a treasury 
note kept at par with gold by being redeemed in gold, then such 
money is obviously one of the things which is determined rather 
than the thing which determines. 

Illustrative Problems. 

1. In the United States in 1870, gold coin was worth $1.21 
per dollar, silver coin $1.23 per dollar, and greenbacks $1.00 per 
dollar. Which, if any, must have been standard money? 

2. For several weeks during the panic of 1837 coined money, 
whether silver or gold, was at a premium of from 2 to 4 per 
cent, while bank notes were at par. Which, if any, must have 
been standard money? 

3. Add to the first problem that in 1870 national bank notes 
were worth $1.00 per dollar and were redeemable in greenbacks. 
Which money, under this condition, must have been standard 
money? 

Principle II. If, among those moneys in any system which 
are a valid tender in the payment of debts, differences of ex- 
change value arise, the cheapest of such valid tender moneys 
establishes itself as the standard money, and the rest go to a 
premium. 

Illustration. — In the first problem under Principle I we have 
three moneys all legal tender and each different from the others 
in value; — the cheapest being worth 21 cents less than the next 
higher and 23 cents less than the highest. Under these condi- 
tions, the cheapest, greenbacks, became the standard money, gold 
and silver going to premiums of 21 and 23 cents respectively. 

Argument. (1) As long as all the moneys in question are 
valid tenders for debts, debtors will choose the cheapest for this 
purpose, thus making that money the standard money for debts. 

(2) For the sake of business convenience, the standard money 
of debts and that of prices are bound to be the same, if possible. 

(3) This is perfectly possible; since, though the standard money 

235 



PRINCIPLES OF ECONOMICS 

of debts is fixed as in (1), that of prices is free to move. (4) 
Accordingly, the standard money of prices will adjust itself to 
that of debts, i. e,, to the cheapest of the valid legal tenders, thus 
making the latter the standard money in general. 

Corollary 1. // two metallic moneys are freely coined and 
full legal tender at a coinage ratio different from the market 
ratio, the money coined from the overrated metal will establish 
itself as the standard money. 

Argument. Suppose that when 1 ounce of gold is on t^..^ 
market worth 16 ounces of silver, the mint treats 1 ounce of goid 
as worth only 15 ounces of silver, putting into each silver coin 
less metal than is needed, considering their market ratio. Under 
these conditions,, each silver coin will be worth less than the 
corresponding gold coin, and so,, by Principle II, will make itself 
standard money. But, when the mint thus treats silver as worth 
less than it really is,, the mint is said to overrate silver. Hence, 
the corollary that the money made from the overrated metal will 
establish itself as the standard money. 

Corollary 2. //, in the case of a legal tender circulating note 
which has hitherto been kept redeemable in what has hitherto 
been standard money, a suspension of payments takes place, such 
legal tender note ii'ill almost certainly establish itself as standard 
money. 

Argument. — Such a circulating note is a mere promise to pay 
what has been hitherto standard money. When the issuer sus- 
pends payment on his promise, its value inevitably falls off. 
People expect he will pay some time but are not willing to give 
as much for a probable future payment as for a certain present 
one. But, when the note becomes worth less than former stand- 
ard money, it inevitably displaces such money under the opera- 
tion of Principle II. 

Illustrative Problems. 

1. In the United States in 1830, both gold and siiver were 
freely coined at a ratio of 15 to 1, when the market ratio was 
15.8 to 1. 

(a) Which metal did the mint overrate? Explain carefully. 

(b) Which of the two moneys, if any, must have been stand- 
ard money? 

2. In 1830 France had a system similar to ours but its ratio 
was 15.5 to 1. 

236 



CHAPTER X. PRINCIPLES OF MONEY. 

Answer the same questions for it, as for the United States 
tinder 1. 

3. Why did the United States have the greenback as its 
standard money between 1862 and 1879? 

4. In 1717 the British government decreed that a gold guinea 
should be treated as the equivalent of 21 silver shillings; though, 
judged by the bullion in them, the guinea was worth 20^ 
shillings. Which must have become standard money? Explain. 

5. In the panic weeks of 1837, bank notes were the standard 
money. (See Problem 2, page 235.) How do you explain it? 

The preceding discussion has concerned the defining and 
determining of standard money. We now bring out two prin- 
ciples which have to do with defining and determining the 
idtimate standard. 

Principle III. // hy any process ivhatsoever the standard 
money is kept constantly equal in zmlue to a definite quantity of 
some outside commodity or group of commodities, such com- 
modity or group of commodities constitutes the ultimate standard 
of the system. 

Illustration. If a country should issue only paper money, but 
should at all times redeem such money in gold bullion at the 
rate of 25.8 grains for each dollar, and, on the other hand, should, 
when it was desired, pay out one dollar in money for every 25.8 
grains of bullion brought in, then the ultimate standard would 
be 25.8 grains of gold; for 25.8 grains of gold would fix the value 
of one dollar. 

Argument. The principle scarcely seems to require proof. 
The condition stated in the theorem ties together in value the 
two things, — standard money and a certain quantity of some 
outside thing, say a lump of gold weighing 25.8 grains. But, of 
these two things, one is plainly more stable, fixed, than the 
other; the value of the lump of gold can change only as all the 
gold on the general market of the world changes, while the 
value of the standard money of one out of many countries might 
fehahge without aflfecting anything but itself. We must, there- 
fore, think of the metal as fixing the value of the money rather 
llian the re;verse. 

" I ) Illustrative Problems. 

1. A few years ago, the United States remodeled the mone- 
tary system of the Philippines, making silver pesos coined only 

237 



PRINCIPLES OF ECONOMICS 

for the government the standard money, but providing that gold 
exchange on New York should be sold to any person wanting it 
in exchange for silver pesos at a rate of $1 for two pesos. Such 
a system tended to establish what ultimate money standard in 
the Philippines? 

2. Great Britain puts into every sovereign US' grains of pure 
gold, coins these sovereigns for every one free of charge, and 
does not attempt .to hinder the melting of coins. Under these 
conditions what necessarily becomes the ultimate money standard 
of Great Britain? Explain fully. 

3. What must have been the ultimate standard of the United 
States in 1830? See Problem 1, page 236. 

4. What must have been the ultimate standard of France at 
the same date? See Problem 2, same page. 

Principle IV. // the standard money is not kept constantly 
equal in value to a fixed quantity of some commodity or group 
of commodities outside itself, but varies in value independently 
of the variations of any other object, then such standard money 
is itself the ultimate standard of the system. 

Illustration. Prior to 1893 British India had as its ultimate 
money standard 180 grains of silver ; i. e., the unit coin, a rupee, 
contained 180 grains of silver and was freely coined, thus making 
the metal itself the ultimate determinant of the value of the 
rupee. But, in the year named, the government stopped the free 
coinage of silver with the result that coins rose in value as com- 
pared with the metal in them, fluctuating from 32 cents down 
towards, but never to, their bullion value, 22 cents. Thus the 
silver rupee had nothing behind it to fix its value — it moved up 
and down independently of anything else. Accordingly, the 
silver rupee fixed the value of the unit ( the rupee) not only 
immediately but also ultimately ; and hence was itself the ultimate 
standard. (This illustration would seem to furnish sufficient 
proof of the principle.) 

Illustrative Problems. 

1. What was the ultimate standard of the United States 
between 1862 and 1879? Explain. 

2. What was the ultimate standard of the United States dur- 
ing the panic weeks of 1837? See Problem 2, page 235. 

3. Suppose, that after 1893 the government of British India 
had so managed things as to keep gold exchange on London 
constantly at 20 rupees for 1 sovereign (123.27 grains of gold). 

238 



CHAPTER X. PRINCIPLES OF MONEY. 

What would then have been practically the ultimate standard of 
India ? 

Section B. The Circulation of Money. 

The second group of monetary principles which we must 
study concern the circulation of money. Will a particular money 
circulate at all? What kinds of money have greater tenacity in 
circulation? To what part of the circulation is a particular kind 
of money likely to gravitate? and so on. These and other 
related questions are of importance because of the fact that in 
the course of events governments have occasion to arrange mat- 
ters so as to keep a particular money in circulation ; or in 
another case so as to drive a particular money out of circulation; 
or in still another so as to keep a particular kind of money down 
to a small stock, though not driving it out altogether; or again, 
so as to segregate a particular kind of money in some special 
part of the system ; and so on. The natural laws regulating 
these matters are fairly numerous ; but here we can bring for- 
ward only two or three of the most important. 

Principle V. Broadly speaking, a money's tenacity in circula- 
tion varies directly a.y* its capacity to do the various kinds of 
money work and the degree to which that capacity is assured. 

Illustrations. A money which is receivable by government in 
payment of taxes has more tenacity in circulation than a similar 
money which is not so receivable. A money which is a legal 
tender in most relations circulates more surely than one which 
is not. Bank notes which can be used as bank reserves by state 
banks have more tenacity in circulation than notes which can not 
be so used. 

Principle VI. In the case of credit money, tenacity in circu- 
lation varies inversely as the difficulty of returning such money 
to the issuer. 

Illustration. If, in order to get a bank note redeemed, the 
holder is obliged to send it to some city hundreds of miles 
distant, paying the cost himself, he is likely to give up the idea 
altogether and content himself with passing the note on in 
buying goods or paying debts. Thus, such notes tend to con- 

*Remember that in Economics "to vary directly as" means only to vary 
in the same direction, not proportionately; and to "vary inversely as" means 
only to vary in the opposite direction, not proportionally. 

239 



PRINCIPLES OF ECONOMICS 

tinue in circulation, rather than going out by return to the issuer. 
Reversing the conditions would, of course, reverse the tendency. 
Argument. The principle probably needs no other argument 
than to make clear that returning to the issuer does actually put 
a credit money out of circulation ; since, assuming this to be 
true, it is obvious that any obstacle to such returning would 
strengthen the hold of said money on the circulation, while the 
rcwioval of that obstacle would weaken its hold. There are 
various ways of showing that a circulation note is retired by 
return to the issuer; but for our own present needs the simplest 
will answer. When a note has been returned to the issuer, the 
situation is precisely what it was before said note had been 
issued at all. But, of course, a note can not be said to be in 
circulation before it has been issued at all. Hence it can not be 
said to be in circulation after return to the issuer. 

Principle VII. {Grcskam's Law.) Comparing (j) moneys 
which have more value in circulation than in any other disposi- 
tion, (2) moneys which have the same value in both connections^ 
and (j) moneys which have less value as money, the first have 
the greatest tenacity in circulation, the third have the least, and 
the second something between. 

Illustrations. (a) If there are circulating side by side two 
gold eagles one of which is of full weight while the other is a 
half grain short, the latter is more likely to remain in circulation 
than the former, (b) Our silver dollar which circulates at par 
though much short in weight, and therefore is more valuable as 
money than as bullion, can hardly be driven out of circulation, 
while full-weight gold coin is constantly being withdrawn, (c) 
If gold and silver coins which are full legal tender and freely 
coined are circulating side by side, and, on account of changes 
in their market ratio, the silver goes to a premium of 2 per 
cent, the gold will circulate as freely as ever, but the silver will 
almost completely disappear. 

The argument for the principle is simple. If a money is 
worth less for outside purposes than as money, no one will be 
tempted to withdraw it. If it is worth more for outside pur- 
poses, no one who knows that fact will be willing to pass it on as 
rnoney. If it is worth the same in both relations, people will 
make either use of it according as circumstances dictate. 

240 



CHAPTER X. PRINCIPLES OF MONEY. 

Principle VIII. In the distribution of the monetary stock 
of a country, money of smaller denominations naturally gravi- 
tates to the Circulation Proper, i.e., the part of the circulation 
which is being used directly as a medium of exchange, money 
of larger denominations, to the Reserves, i.e., the funds kept by 
banks and other institutions to meet credit obligations. 

Illustration. If we allow some particular kind of money to 
be issued only in large denominations, say $25 and upward, we 
thereby almost completely shut such money out of the circula- 
tion proper. Again, if we allow another money to be issued 
only in $1, $2, and $5 denominations, we almost completely ex- 
clude such money from the reserves, provided we do not issue 
much more than can be utilized in the circulation proper. 

Argument. This principle has been proved in experience, 
but is most easily established by reference to the conditions of 
the case. The circulation proper, the part of the money stock 
actively engaged in exchanging goods, will certainly draw to 
itself that kind of money which is fitted for its special work. 
But, obviously, there will in ordinary trade be comparatively 
little need for money of large denominations, especially in a 
community which makes much use of checks, and great need for 
money of small and middle denominations, to effect purchases, 
make change, etc. 

Illustrative Problems. 

1. In 1849, when the United States had free coinage of both 
gold and silver, a change in the relative values of the two 
metals sent silver coin to a premium, i.e., two silver half-dollars 
were worth $1.02. What naturally happened to silver coin? 

2. During the Civil War, the government of the United 
States thought best to borrow money by paying soldiers, con- 
tractors, et at., with treasury notes. Yet it was desirous that 
these notes should not be added to the circulating medium, but 
should soon get into the hands of people who would lay them 
one side and hold them till they were due, — in other words, 
treat them as bonds. The Treasury finally hit on a pretty good 
plan to accomplish this. What was it? 

3. In 1862, when gold payment on treasury notes had al- 
ready been suspended, the United States began the issue of 
legal tender notes. In consequence gold went to a premium, 
soon being worth $1.15 per dollar. What naturally happened 
to it? 

241 



PRINCIPLES OF ECONOMICS 

4. Experts consider it very desirable that the bank note 
circulation should be elastic, — should expand readily when the 
need for money increases and contract promptly when the need 
diminishes. Of these two phases of elasticity, the second is in 
a sense the more important, in that it really provides for the 
first. In order to secure this power of prompt contraction, vari- 
ous provisions have been enacted or proposed; (a) establish a 
good many redemption agencies at convenient points throughout 
the country; (b) prohibit any bank from paying out in regular 
business the notes of another bank except in the city or district 
where the issuing bank is located; (c) prohibit the use of bank 
notes as reserves by banks outside the system ; (d) take away 
the right of legal tender to government; and so on. 

Explain in each case why the provision set forth would nat- 
urally contribute to the contractility of the note circulation. 

5. In 1894, on account of excessive issue of silver and 
pciper money, as also on account of the marked decline in busi- 
ness activity, the United States had a great excess of circulating 
medium. This fact (combined, doubtless, with other causes) 
led to a considerable contraction by export to other countries. 
What kind of money must have gone? 

6. In 1886, Congress provided by law for the issue of silver 
certificates of $1, $2, and $5 denominations, and in 1900i decreed 
that 90 per cent of the total amount of such certificates should 
be in denominations from $10 down. Try to find out what they 
hoped to accomplish by this legislation. 

Section C. Movements and Distribution of Money. 

In spite of the fact that money payments between different 
communities are largely effected by a cancellation of reciprocal 
credits, there necessarily take place many transfers of money 
itself. These money movements are often of importance, both 
because at times they tend to modify in undesirable ways the 
distribution of the monetary stock among different communities 
and because at times they indicate more or less diseased condi- 
tions of the industrial or monetary system as a whole. We here 
set forth a few of the most important principles regulating these 
movements. 

Principle IX. The dealings of one country {community) 
with other countries in respect to goods and capital do not in 
themselves naturally lead to net movements of money either to 
or from said country; hut, if circumstances are such as to main- 
tain a balance of claims for or against said country for a period 

242 



CHAPTER X. PRINCIPLES OF MONEY. 

of several weeks, a net movement of money to or from that, 
country is probable. 

Argument. A. The first clause of the theorem needs to be 
established under each of two hypotheses; (1) when interna- 
tional dealings are effected through credit mostly, and (2) when 
such dealings are effected through cash payments. Under hypo- 
thesis (1), the truth of the theorem is evident. The principle 
that trade is in its nature reciprocal, which we had early in our 
course, tells us that we shall sell as well as buy, — that claims for 
us will naturally match claims against us. Consequently, trade 
as such will not naturally lead to any movement of money. 
Under hypothesis (2), money movements, by the terms of that 
hypothesis, take place; but these are not net movements — move- 
ments which show a balance one way or the other. The for- 
eigner does not naturally take from us more money than he 
brings to us; because his only use for money is to buy things. 
Money is a mere go-between; the real thing sellers want is the 
good they later buy with money. Money, therefore, naturally 
comes back as surely as it goes away. 

B. The second part of the theorem is no more troublesome 
than the first. If a country is for several weeks selling much 
more than it buys, so that there is a large balance of claims in 
its favor, its bankers or exchange dealers will be unwilling to 
wait for their pay till the tide turns and so will probably order 
money itself sent to them. 

Corollary 1. Money tends to How to any country {community') 
zvhere the rate of discount is exceptionally high, and vice versa. 

Argument. Such a condition of things tends to cause a flow 
of capital to said country, hence tends to establish a balance of 
claims in favor of that country, and so tends to bring into opera- 
tion Principle IX. 

Corollary 2. Money tends to How from a country where the 
stock is abnormally large as indicated by the state of the central 
reserves. 

Argument. This corollary follows from its predecessor. An 
excessive money stock causes excessively large bank reserves, 
which cause a fall in the rate of discount, which brings Corollary 
1 into operation. In extreme cases, an excess of money raises 

243 



PRINCIPLES OF ECONOMICS 

prices, and by this causes an inflow of imports, then a balance 
against the country, and finally an outflow of money. 
•■ Corollary 3. There tends to he a continuous net How of 
money from a country which is a producer of standard money 
metal. 

Argument. The natural and easy way to market standard 
money metal is to take it, directly or indirectly, to the mint, have 
it turned into money, and sell it as money, i. e., spend it for 
goods. But this means that the money stock of a gold pro- 
ducing country is being constantly augmented, and is constantly 
becoming excessive. This brings into operation Corollary 2. 

Corollary 4. Money tends to flow from any country which 
has experienced a marked decline in industrial activity: 

Argument. The condition named makes the money stock 
excessive, — since there is less money work to be done, — and so 
brings into operation Corollary 2. 

Corollary 5. // a full weight metallic money comes to com- 
mand a premium, it tends to he exported from the country. 

Argument. When such a money goes to a premium, it natur- 
ally ceases to circulate — to be used as money, Principle VII 
above. But, ceasing to be used as money, it is thrown on the 
metal market, making the supply excessive and hence making its 
value at home low as compared with its value in other countries. 
That is, the premium it bears at home is less than its value 
abroad would seem to justify. It is, therefore, exported. 

Principle X. Every net movement of money tends to he 
stopped, or even reversed, by the automatic reversal of that con- 
dition which is necessary to hring it ahout, or hy the action of 
conditions which its own continuance sets up. 
. Argument. (Reading XVI.) A. A money movement — e. g., 
an outflow — tends to be stopped, even reversed, by the automatic 
reversal of the condition which immediately brings it about. 
The condition here alluded to is a high rate of exchange. With- 
out such a high rate, money will not normally go. But a high 
rate of exchange is, so to speak, self-reversing, in that it makes 
the exporting of goods unusually profitable, hence stimulates 
competition among exporters, so leads them to shade prices, con- 
sequently stimulates foreign buying, thus makes exchange abun- 
dant, and so lowers the rate. 

244 



CHAPTER X. PRINCIPLES OF MONEY. 

B. A money outflow, if long continued, sets up conditions 
which tend to stop or reverse the movement. Such an outflow 
makes banking reserves in the commercial centers (New York, 
London) scanty, hence raises the rate of discount, therefore 
checks buying of securities, consequently lowers their prices, 
hence stimulates foreign buying, thus makes exchange abundant, 
therefore lowers the rate of exchange, and so removes the con- 
dition which is necessary to further outflow. 

Corollary. There is never any danger that an outflow of 
money from a particular country will go on till that country is 
denuded of its monetary stock. 

Principle XI. Generally speaking, the monetary stock of a 
country, or group of countries having the same standard, tends 
to distribute itself according to relative need. 

Argument. This principle ought perhaps to be given as a 
corollary under Principle IX. But its importance justifies its 
presentation as a separate theorem. The reasoning on which it 
is based is simple. If the monetary stock of a particular country 
is relatively excessive, bank reserves expand, the prices of secur- 
ities (and ultimately of goods) rise, foreigners sell freely on 
our markets, our foreign debt expands, exchange rises, and 
money goes, thus reducing the plethora. On the other hand, a 
relatively deficient stock of money makes bank reserves low, the , 
rate of discount (not exchange) rises, home buying falls off, 
prices fall, foreign buying is stimulated, exchange becomes 
abundant, the rate of exchange falls, and money flows in. 

The above argument treats the matter as things work between 
highly developed commercial nations in the ordinary course of 
things. As between the small communities where standard 
money metal (gold) is produced, e. g.. South Africa, the Klon- 
dike, etc., and the rest of the world, the working of things is, if 
anything, more simple. The extraordinary abundance of money 
(for gold here at once becomes money even in its raw form) 
and the great scarcity of all other goods makes prices excessively 
high, goods flow in at an extraordinary rate, the community has 
constantly a large balance of indebtedness against it, and money 
must constantly be sent out. 

Principle XII. While, in general, the proper distribution of 
the world's monetary stock among the different nations can safely 

245 



PRINCIPLES OF ECONOMICS 

be left to the working of automatic forces, circumstances may 
arise under which it is desirable consciously to control particular 
movements of money, in order to maintain the stability of the 
system of credit. 

Argument, The student is already familiar with the fact that 
our exchanging medium consists in large part of credit money, 
promises to pay real money, and, in still larger part, of mere 
credit, bank credit, deposit currency. Now, it is plain that, 
under such an order of things, the foundation of real money on 
which the whole system rests, is vastly more important than any 
other constituent of the circulating medium; and this is particu- 
larly true of that portion of the stock of real money which we 
call the ultimate reserve, the reserve kept by a great central bank 
or, as in our case, by the government to redeem credit money. 
If this reserve is exhausted, the standard goes, the system falls 
to the ground. Thus, every export of standard money threatens 
to take away the very foundation of the system. It is, there- 
fore, perfectly natural that the banking community should view 
with apprehension an excessive outflow of such standard money. 
It is also perfectly natural that, if such an excessive outflow 
continues, they should call for some action on the part of gov- 
ernment or of the central bank to check the outflow. As a 
matter of fact, the great banks of Europe have developed several 
more or less efficient devices, policies, having this end in view. 
Of these the most important consists in raising the rate of 
discount and thus bringing into operation Corollary 1 of Prin- 
ciple IX. 

Illustrative Problems. 

1. "When I came to Marblehead they had their houses built 
by country workmen, and their clothes made out of town, and 
supplied themselves with beef and pork from Boston, which 
drained the town of its money." — Barnard's Autobiography. 
Criticise the part in italics. 

2. During the years 1853 to 1864, inclusive, when France had 
a system of bimetallism at a coinage ratio of 15.5 to 1, while the 
market ratio was about 15.3 to 1, the French circulation ab- 
sorbed about $680,000,000 of gold, and ejected about $345,000,000 
of silver. Explain these facts, using one of the corollaries of 
Principle IX. 

3. Between America and Europe there is usually a net move- 

246 



CHAPTER X. PRINCIPLES OF MONEY. 

ment of money toward Europe during the second quarter of the 
year, toward America near the end of the third, and early in the 
fourth, quarter." Explain why you would expect this to be true. 

4. "A country has never been despoiled of its money by the 
working of its international trade." — Gide's Political Economy, 
p. 120. Why does he feel so sure about this? 

5. A New York wheat broker sells 50,000 bushels of wheat 
to a Liverpool miller, and sells against it a sight bill of exchange 
for the proceeds, £873'5 16s. The wheat cost him 84 cents per 
bushel. 

(a) With exchange on London at $4.88, what would his 

profits be? 

(b) What would they be with exchange at $4.84? 

(c) What has this got to do with money movements? 
Explain carefully. 

6. "Between New York city, as the banking center of the 
United States, and the country at large, there is usually a great 
money movement outward from New York during the summer 
and early fall, and an inward movement toward New York 
during the late fall or early winter." Explain why you would 
expect this to be true. 

7. Argument for a subsidy to the American merchant marine : 
"We pay 110 million dollars per annum for the carrying of 

products between this and foreign countries. Think of it. One 
hundred and ten million dollars in gold coin has gone out of the 
commerce of this country into the commerce of other countries. 
Can New York stand this?"— James G. Blaine, 1881. (a) Did 
our paying $110,000,000 for the carrying of products mean that 
$110,000,000 in gold coin went out of this country each year? 
(b) If $110,000,000 in gold coin were to go each year for this 
purpose, would we be any poorer because of it? (c) Would it 
be any better if we could meet the obligation by sending out 
$110,000,000 worth of cotton or wheat rather than so much gold? 
(d) Could we, as a matter of fact, send out $110,000,00 in gold 
each year for this or any other purpose? Why? 

Section D. The Value of Money. 

Thus far in our discussion of value and price, it has been 
assumed that money itself, the thing in which the values of most 
goods are expressed, is constant in value. This way of conceiv- 
ing the matter has been encouraged by our emphasis on the 
idea that the money unit is tied to a certain definite quantity of 
substance, say 25.8 grains of gold, just as a gallon measure is 
tied to 8.33 pounds of water. But we must now call the student's 
attention to the fact that such a way of looking at the matter 

247 



PRINCIPLES OF ECONOMICS 

is more or less inaccurate. The cases of the money standard 
and the liquid measure standard are not precisely analogous. 
In using 8.3S' pounds of water as a standard of liquid measure, 
we need have no anxiety that the bulk of the water itself will 
change, and so cause that of our unit to change, since we can 
make those conditions which can modify the hulk of water — 
temperature and atmospheric pressure — absolutely the same in all 
cases. But we can not parallel such an operation with gold and 
its value. We can not say that we will have as our money 
standard the value of 25.8 grains of gold under just the same 
essential conditions as prevailed when it was -finally adopted in 
1S73; for we can never reproduce those conditions. All we can 
do, and all we try to do, is to keep the value of one dollar the 
same at any one time as the value of 25.8 grains of gold is at 
that same time. We know that in so doing we are tieing the 
dollar to something which itself changes. But we are doing 
what seems the best thing possible under all the conditions of 
the case. Gold probably changes as little as any single coiYi- 
modity. Further, as being the standard of all important coun- 
tries, it is far better than any other. But it no doubt changes 
in value, and so, of course, our money changes in value. 

We have just said that gold, and so money, undoubtedly 
changes in value. But it is not as easy to establish the fact of 
change or to measure its amount as the student might imagine. 
Gold being the standard of all great commercial nations, there is 
practically no market where its value is expressed in terms of 
something besides itself. There is, therefore, practically no 
place where its apparent value, its money price, changes at all. 
In the United States it is always worth $18.67 per ounce; in 
Great Britain, £3 17s 10^ d per ounce; and so on. Our only 
method of ascertaining changes in the value of moneys is to 
sXndy the movements of the prices of other things. If gold, 
and so money, should all at once greatly rise in value, its own 
price would remain constant, but that of every other thing would 
fall. On the other hand, a sudden fall in the value of gold 
would show in a rise of the prices of all other things. It would 
seem, therefore, that we need only to ascertain the changes in 
the general level of prices to know the changes in the value bi 
■money; and, in large measure, this is what we try to do. : 

248 



CHAPTER X. PRINCIPLES OF MONEY. 

But here again we find trouble. Changes in the value of 
money would surely express themselves in opposite changes in 
the level of prices. But the level of prices may be changed by 
other causes ; e. g., sudden collapse of business demand, great 
fall in cost of production. In other words, a change in the 
general price level may really be, not a change in the value of 
money, but a change in the value of goods. Or, if this method 
of expressing the matter is objectionable, we may say that some 
changes in the general level of prices have their origin in causes 
affecting goods rather than money, and, if called changes in the 
value of money at all, these may be distinguished as relative 
changes; while changes in the price level due to causes acting on 
money itself would be called absolute changes. 

The preceding discussion has brought out the nature of 
changes in the value of money, let us now remark on the most 
important principles governing these changes. 

Principle XIII. // there takes place any change in condi- 
tions outside the monetary system tending to cause a change in 
the supply of, or the demand for, goods in general, or to cause 
a widespread change in the cost of producing goods, said change 
in conditions will also tend to cause the corresponding change in 
the general price level; hut such a change will he merely a rela- 
tive, not an ahsolute, change in the value of money. 

Illustrations. A. When, after a period of industrial stagna- 
tion, business begins to pick up, — people begin to have faith in 
the future, — there naturally takes place a considerable expansion 
of demand for goods of all sorts, and in consequence a measur- 
able rise in prices, beginning among a few commodities but 
gradually extending until it covers, if not the whole field, at 
least a large portion of it. As the boom advances, this move- 
nient becomes more and more pronounced. Every one believes 
prices will go higher, and so is eager to buy, that he may have 
something to sell at these higher prices. But of course his 
eagerness to buy means more demand and so more advance in 
prices. This self-propagating movement continues until the 
expansion has passed all reasonable bounds, when suddenly some 
accident precipitates a general collapse of the boom, — pricks the 
speculative bubble. At once all are eager to sell, no one want- 
ing to buy ; and this sudden expansion of supply and contraction 
" " 249 



PRINCIPLES OF ECONOMICS 

of demand causes a falling off of prices, more rapid probably 
than the rise has been. 

B. If throughout a period of considerable length, say be- 
tween 1850 and 1890, there occurs a widespread improvement in 
technical methods so that the costs of producing large numbers 
of commodities are greatly reduced, there naturally follows a 
decline in the prices of these commodities, so marked as to 
lower considerably the average, or general, price level. But 
such a lowering of the general price level could not properly 
be conceived as a real or absolute advance in money. It has 
taken place, not because something has happened to money, 
but because something has happened to goods. To employ a 
common method of expression, it is not a change in the value of 
money at all, but rather a change in the value of goods. 

These illustrations of the Principle would seem to furnish 
all the argument it needs. In fact, the theorem is formally 
presented chiefly to guard the student against confusing price 
changes of the kind here considered with those more important 
ones which constitute real or absolute changes in the value of 
money. 

Principle XIV. Whenever the conditions are such that it 
is possible for the general public to have substantially conclusive 
evidence that a change in the value of the standard, as meas- 
ured in at least one important commodity, has taken place, there 
will almost certainly follow, more or less rapidly, a direct read- 
justment of general prices to the changed standard. 

Illustration. A. Before 1893, India had a silver standard; at 
the same time the value of silver was constantly fluctuating in 
the London market; and these fluctuations were manifested in 
India by changes in the rate of exchange on London. Under 
these conditions frequent readjustments in the prices of goods — 
particularly the prices of imported goods — took place in re- 
sponse to the changes which occurred in the value of silver. 

B. During the Civil War in the United States, the standard 
money — greenbacks — greatly fluctuated in value, as measured in 
gold, which it had temporarily displaced. Its buying power as 
money also fluctuated in a fashion roughly corresponding to its 
fluctuations as measured in gold, — a result which seems to have 
been effected by a more or less conscious readjustment of prices 

250 



CHAPTER X. PRINCIPLES OF MONEY. 

to changes in the value of standard money (greenbacks) as 
measured in gold. 

This principle, like the one preceding, hardly seems to need 
further proof than the illustrations furnish. We could probably 
be sure that business men of experience, alert and shrewd, would 
refuse to sell goods at the old prices for money which had fallen 
twenty to thirty per cent in what they were accustomed to con- 
sider the world standard. 

Princle XV. During a period marked by much uncertainty, 
either political or comm^ercial, the value of irredeemable paper 
money is chiefly determined by public confidence in its ultimate 
redemption, varying directly as said public confidence. 

Argument. (1.) The value of said irredeemable paper, as 
measured in the standard money in which credit money has 
hitherto been redeemed, is in a time of much uncertainty chiefly 
dependent on the likelihood that redemption will be resumed. 
This seems almost self-evident. Great uncertainty of any sort, 
fears of defeat in war, anxiety lest government should repudiate 
in greater or less degree its note obligations, — these naturally 
overbalance all other forces, making a note worth 60 cents today, 
43 tomorrow, 55 the next, and so on. 

(3.) But, if the value of irredeemable paper, as measured in 
the old standard, fluctuates with public confidence in its ultimate 
redemption, and if, as declared in Principle XIV, the value of 
such paper, as money used to buy goods, is roughly readjusted 
to its value as measured in the old standard, then the value of 
such paper varies with public confidence in its ultimate re- 
demption. 

Principle XVI. // there takes place any change in condi- 
tions directly affecting money itself which tends to cause a 
change in the demand for goods in general, said change in con- 
ditions will also tend to cause a corresponding change in the 
general price level, and such change will constitute an absolute 
change in the value of money. 

Illustration. Suppose that in a community which contains only 
a few thousand inhabitants there occurs a great gold discovery, 
and in a few months bullion to the value of hundreds of thou- 
sands of dollars is brought out. As such bullion can be almost 
instantly turned into money or its equivalent bank credit, there 

251 



PRINCIPLES OF ECONOMICS 

will take place at once a great expansion in the money demand 
for all sorts of goods, while no corresponding increase in their 
output takes place. (In fact, the latter rather diminishes be- 
cause people desert other industries to hunt for gold.) In con- 
sequence, a rapid rise in general prices takes place. And this 
rise in prices is a real or absolute fall in the value of money; 
since it is obviously the increase of money or its cheapening 
(in cost) or both which cause the change. 

The above illustration contains the gist of the argument for 
the Principle. 

Corollary 1. The value of money tends to vary inversely as 
the total quantity of money in general in the country or in the 
whole group of countries having the same standard. 

Argument. If the quantity of money increases, the demand 
for goods naturally increases, and so the level of prices tends 
to rise, i. e., the value of money tends to fall. A similar course 
of reasoning would show that a diminution in the volume of 
money tends to increase its value. 

Caution. It is probable that under modern conditions few 
actual changes in the value of money are traceable to changes 
in the total quantity, save in countries which have a fiat money 
for the standard, or in small districts where standard money 
metals are being mined. 

The reason for this is that there is a very high degree of 
elasticity in the monetary system of almost any advanced coun- 
try, and so changes in volume, whether causing excess or de- 
ficiency, are easily corrected. This great elasticity is due to 
various conditions (1) As most nations have the same standard 
— gold — a deficiency in one is easily made good by imports from 
elsewhere, while an excess is easily relieved by export. (2) Most 
advanced commercial peoples make an extensive use of credit 
media of exchange, and these are in the highest degree elastic, 
expanding or contracting rather as the needs of business expand 
or contract than as the volume of money changes. (3) In most 
cases one of the moneys (the band note) is highly elastic. 

Corollary 2. The value of money tends to varry inversely as 
the quantity of standard money available, and hence to vary 
inversely as the output of metal, directly as the cost, directly 
as the quantity used in the arts, and so on. 

Argument. A. In so far as changes in the quantity of 
standard money affect the total quantity of money, they ob- 
viously tend to bring into operation Corollary 1. 

252 



CHAPTER X. PRINCIPLES OF MONEY. 

B. But changes in the quantity of standard money have other 
more potent methods of influencing the value of money. This 
kind of money, as we have remarked more than once, occupies 
a very fundamental place in the system. A deficiency or excess 
of such money is more promptly felt than a deficiency or excess 
of any other kind. In the chief commercial center of the coun- 
try there must be kept one or more great reserves of standard 
money to secure the maintenance of the system as a whole. In 
most countries this reserve of standard money is identical with 
the ultimate banking reserve ; so that excess or deficiency in 
standard money means excess or deficiency in the reserve which, 
as we saw under Principle X, plays such a part in the outflow 
or inflow of money. Under such a system, the addition of a 
few millions of gold, constituting a very small fraction of the 
total money stock of the country, might establish that super- 
fluity in the central reserves which causes a low rate of dis- 
count and so a rise in prices, while a similar subtraction of only 
a few millions would bring about that deficiency which causes a 
rise in the rate of discount and so a fall in prices. In the case 
of the United States, changes in the amount of standard money 
are not so potent, since we use for the central reserve not only 
gold but also legal tender treasury notes. Even so, however, 
changes in the quantity of standard money, as being one of the 
only two moneys which do make up those reserves, affects their 
volume very decidedly, as bank notes, silver, etc., usually can 
not; and, therefore, such changes in the quantity of standard 
money have much more power to influence the general level of 
prices, i. e., the value of money. 

Caution. While changes in the quantity of standard money, 
and so of standard metal, are doubtless more potent to alter the 
value of money than are changes in the quantity of money in 
general ; still, theory and experience alike indicate that changes 
in the value of money certainly traceable to this cause are un- 
expectedly small in amount. This certainly proved true of the 
additions to the stock of gold due to the famous Californian 
and Australian discoveries. Whether a similar statement will 
prove true of the recent extraordinary expansion of gold pro- 
duction, no one can as yet tell us. Money has probably some- 
what fallen in value from this cause; but the fall has probably 
been smaller than the public commonly suppose, and may in the 
end prove insignificant. 

Corollary 3. The value of money in any country, or group 

253 



PRINCIPLES OF ECONOMICS 

of countries having the same standard, tends to vary directly as 
the need for it, i.e., as the money work to he done, — especially 
as the need for standard money. 

Illustration. When, in a country making large use of credit- 
exchange, there takes place a collapse of credit such as marks 
a panic, so that credit media of exchange will no longer do the 
work — money only will be accepted, — almost certainly there will 
occur a marked fall in general prices, i.e., a rise in the value of 
money. 

Argument. The student can easily construct the argument 
for this corollary for himself. It is almost identical with what 
is given under Corollaries 1 and 2. 

MISCELLANEOUS PROBLEMS UNDER MONEY. 

1. "I can't understand what people mean when they say 
that money has risen in value since 1873. Money is by common 
consent the measure of the values of all other things; and so 
its own value must he iixed, — can not rise or fall." — From a 
gold advocate in 1896. Explain his mistake. 

2. Why would changes in the total quantity of money in the 
United States between 1862 and 1879 naturally have had more 
influence on its value than equal changes would have had be- 
tween 1850 and 1860? 

3. Extract from a speech in the campaign of 1896 : "If any 
man in this community would offer to buy all the eggs at 25 
cents a dozen, and was able to make good the offer, nobody 
would sell eggs for less, no matter what the cost of production, 
whether one cent or five cents a dozen. So with silver. Free 
coinage would estahlish the market price of silver at $J.2g, and 
nobody would sell for a cent less." 

There is doubtless a sense in which the italicized claim is 
true; but this is not the sense which was intended. The 
speaker meant that silver would rise to $1.29, as measured in the 
present dollar; so that there would be no repudiation of debts 
in adopting the free coinage of silver. 

(a) Show that such a claim is not established by this 
argument. 

(b) In what sense is the statement true? 

4. "We have altogether too little money in the country 
($2,600,000) not enough to pay the railway debt ($6,000,000), 
or even the debts of banks to depositors, let alone the business 
debts." Explain fallacy. 

5. A few years ago Mexico had a silver standard. If at 
that time silver had risen in value, would the Mexican dollar 

254 



CHAPTER X. PRINCIPLES OF MONEY. 

have risen in value? Would it have risen in price? Would 
the price of silver bullion have risen? 

6. In 1856 the monetary system of France was bimetallism 
at the ratio of 15.5 to 1. The market ratio at that date was 
about 15.3 to 1. What must have been the monetary standard? 
Prove. 

7. In the panic of 1S93, when in America money was so 
scarce that business men and bankers had to resort to all sorts 
of substitutes, such as due bills, New York drafts, deposit cer- 
tificates, etc., an eminent American economist said in substance : 
"What do you think now? Was I not right in contending 
that the stock of money is altogether insufficient?" Did the 
facts establish his contention? 

8. Argument against Bryan in the campaign of 1896: "I 
can see how free coinage is going to increase the profits of the 
mine owners hy doubling the value of silver; but I do not see 
how it is going to help the rest of us." Explain the fallacy in 
the words italicized. 

9. During the sixth decade of the XIX Century when France 
had bimetallism at a ratio of 15.5 to 1, though the market ratio 
was about 15.5' to 1, dealers to their surprise every now and 
then received silver five-franc pieces in payment for goods. Why 
should this have surprised them? 

10. "Unless the government redeems all worn coins at their 
face value, a coinage in active use always shows a strong tend- 
ency to deterioration." Explain why this is bound to be true. 

11. "I object to our buying outside anything which we can 
produce at home; for this means just so much money lost 
from our coin circulation," Show that this is unsound. 

12. About 1850, when the United States had bimetallism at a 
ratio of 16 to 1, there took place a considerable fall in the silver 
price of gold, so that the silver in an American silver dollar was 
worth 2 to 3 cents more than the gold in a gold dollar. In con- 
sequence, silver coins generally went out of circulation, only 
the much worn ones remaining. Explain (a) why most went 
out and (b) why some stayed. 

13. What is meant by saying that our mint ratio between 
gold and silver was 15.98 to 1? 

14. "New York, Dec. 11, 1903. The banks gained from the 
interior this week $2,042,906." — Newspaper. Was this normal? 

15. "London, Oct. 3. One hundred and fifty thousand 
pounds sterling gold will be shipped tomorrow to New York," 
Was this normal? 



255 



CHAPTER XL 
SOME SPECIAL CASES OF PRODUCTION. 

Almost at the beginning of our study, in Chapter II, we 
discussed the true nature of production as understood by the 
economist. At that time we emphasized strongly the breadth 
of the concept, showing that every act tending to increase util- 
ities, if done in response to an economic motive, is a productive 
act. Putting the matter in slightly altered shape, it was said 
that every act which overcomes any one or more of the many 
obstacles which lie between our wants and their gratification is 
necessarily a productive act. Still again, changing slightly our 
statement of the matter, it may be said that every sort of action 
which plays a part, performs a function, in the working of the 
present economic order, is truly productive. These considera- 
tions would seem to furnish adequate criteria in deciding whether 
or not' any particular activity is productive. We have only to 
settle whether that activity increases utilities or removes some 
obstacle to our gratifications or performs some function in the 
general economic order. Further, the application of these or 
similar criteria would seem to be sufficiently easy to render need- 
less any further discussion of this matter. In fact, however, it 
is not always the simplest matter in the world to discover just 
what function a particular activity performs ; and, anyhow, com- 
mon opinion has so long doubted or denied the productivity of 
certain lines of business that some special discussion of these 
particular cases seem almost necessary at some stage of our 
study of elementary economics. The present connection may be 
taken as furnishing a fairly satisfactory opportunity for attend- 
ing to this task. 

Section A. Insurance. Is it Productive? Has it a 
Real Economic Function ? 

A discussion of this question is doubtless less necessary than 
a generation or two ago when not a few persons looked on this 
business as little removed from gambling. Even now, however, 

256 



CHAPTER XL CASES OF PRODUCTION. 

many persons who consider insurance quite legitimate would 
hesitate to call it productive. There is no ground for such hes- 
itation. Every business which furnishes a service of any sort, 
which performs any function called for in the economic order, 
is productive. And insurance certainly performs such a function. 
That function is to provide for the bearing of the risk burden 
characteristic of economic relations in such a way that that bur- 
den will be most easily borne, will work least economic injury. 
If insurance does this, it surely creates utilities, performs serv- 
ices. That such is the work it accomplishes is easily shown. The 
essence of insurance is the pooling, putting into one mass, of a 
large number of risks, in other words, acting as one person in 
the bearing of risks. By doing this we substitute a series of 
certain small losses for a chance of a great loss. To illustrate, 
suppose we take 1,0'00 houses, owned by 1,000 persons, each 
house worth $2,000. To each owner the burning of his house 
would mean a loss of $2,000; and, since nothing can be known 
in advance as to the likelihood of its burning, each owner's con- 
stant risk equals $2,000, the entire value of his house, one hun- 
dred per cent. But, if all these houses be taken together, the 
case is very different. From statistics as to the past working of 
things we can be sure that, say, three but not more than three 
out of the thousand houses will burn each year, and so that the 
total risk on the houses, the risk on the whole number taken 
together, is only $6,000 per year on a total value of $2,000,000. 
Distributed over 1,000 owners this means a payment of $6 per 
year. Thus by making small payments every year a man may 
get rid altogether of the risk of losing $2,000. This surely is a 
profitable transaction. A real utility has been created. The 
probable efficiency of industry has been enhanced ; since the 
injury or burden to industry as a whole due to the collecting of 
a series of small anticipated payments from all owners is vastly 
less than that which would result from an unexpected loss of 
$2,000 falling on each of three persons each year. The operation 
is therefore productive. 

NOTE : This making a regularly recurring payment to avoid 
the chance of a great loss is in no sense gambling. Gambling is 
the assumption of needless risk. Here the risk is unavoidable. 

The preceding discussion has justified only mutual insurance, 
insurance where the insured co-operate. Is the case of Specu- 

257 



PRINCIPLES OF ECONOMICS 

lative insurance — company insurance — good? Surely, yes. There 
is no essential difference between the two cases. All insurance 
is mutual, ?', e., it is only through the pooling of the risks of 
many owners that insurance is possible. The real program, the 
general plan, is the same in both co-operative and company in- 
surance. The only difference is in the process of carrying out 
the program. On the co-operative plan, the insured themselves 
undertake to effect and manage their mutual insurance. On the 
company plan, an outside body undertakes this job, i. e., the 
effecting and managing of the mutual insurance. In doing this, 
the company obviously furnishes a service additional to that of 
mere mutual insurance, i. e., it performs the regular entre- 
preneur function and so in a twofold sense produces wealth. 

Illustrative Problems. 

1. Suppose 1,000 owners of 1,000 buildings worth each $7,000 
Adsh to insure themselves against fire. If the risk for the class 
of buildings involved is such that 7 out of 1,000 burn down each 
year, what annual payment from each owner would be necessary 
to insure all against total loss, — expenses of management, etc., 
being ignored? 

2. Suppose 1,000 persons propose each to save for his fam- 
ily before his death, $2,0C0. All are twenty-five years of age. 
Knowing that anyone is liable to die before he has had time to 
savfe so much, they combine to insure one another that $2,000 
shall be ready for the family even if death comes before that 
sum has been regularly accumulated. Assuming that the organ- 
ization is continuous, new members joining as old ones pass 
away, and, assuming the average annual death rate to be 8 in 
1,000, what annual payment would each one need to make, — 
expenses of mnagement, interest, etc., being ignored? 

3. Suppose that a certain corporation owns 500 buildings 
worth each $100,000; that to insure in an ordinary company 
would cost the corporation $250 a year on each building; and 
tliat the corporation is convinced that by the expenditure ^ of 
$10,000 the fire loss can be reduced to an average of one build- 
mg every three years. Under these conditions, would it pay 
the corporation to insure with some company? Prove. 

Section B. Speculative Trading. Is it Productive? Has it 
an Economic Function ? 

Here, as in the case of insurance, the answer is affirmative, 
though in this case not without qualification. Much which passes 
for speculation is gambling pure and simple ; much more, though 

258 



CHAPTER XL CASES OF PRODUCTION. 

legitirratfc in form, is in spirit nothing different from gambling. 
I. Produce Speculative Trading. 

(1) The nature of Speculation, 

To speculate is to deal in goods with purpose of gaining a 
profit from price changes in the same market. In this it con- 
trasts with mercantile trading which seeks profit from price 
differences in different markets forming members of a series. 

Illustration : When a dealer on the Chicago wheat market 
agrees in December to deliver wheat in May, believing that he 
will be able to buy it at a lower price than the one agreed upon, 
he is speculating. When the same man buys wheat on the same 
exchange and sells it to a miller in Rochester, he is engaged in 
the regular trade. Of course he makes a profit, but that profit 
is due to the difference of price between the wholesale market 
and the miller's market. 

(2) Speculative Markets, Exchanges, Boards of Trade, 
Bourses. 

The most thoroughgoing forms of speculation are carried on 
in special markets, called by various names, of which the wheat, 
cotton, and stock exchanges are the most conspicuous examples. 
Some of the more notable characteristics of these exchanges are 
the following: 

(a) Trading in common; all dealers in the involved com- 
modity coming together in a complex of buying and selling, 
(b) Open trading; no privacy as respects other traders, bar- 
gains known to all in respect to prices, amounts, etc. (c) Trad- 
ing through official dealers, brokers, (d) Large scale dealing, 
(e) Major part of trading, speculative, (f) In produce mar- 
kets, trading in futures usually present. 

(3) Chief Functions of Speculation. 

(A) To establish proper price. (B) To secure the bearing 
of the risk burden of ownership in the easiest and cheapest way. 

(4) Function A Considered. 

(a) As already strongly emphasized, the securing of the 
proper price, i. e., the price which is demanded by the real con- 
ditions of output and need, is a matter of great importance ; 
since it is chiefly through price that the automatic regulation of 
economic action is effected. 

(b) Free speculation, with ample competition on both -sides 
of the market, is the natural way to secure the proper price, the 

259 



PRINCIPLES OF ECONOMICS 

price which ought to prevail in view of the real condition of 
need and output. 

CAUTION : It must be admitted that, in the present con- 
dition of speculative trading when public control is undeveloped 
and the standards of business morality are very low, true 
speculation is often mingled with many forms of dishonest 
m.anipulation which more or less hinder the establishment of 
proper prices. Commonly, however, these influences are very 
short-lived; in the long run the real, underlying forces regulate 
the market. 

(5) Function B Considered, 

(a) All ownership of property involves the risk of loss from 
changes in value. The miller who, in December, buys wheat that 
will not be marketed as flour till April runs the chance that 
wheat and flour will both fall in price between the two dates, 
and so he will have to write off a loss. 

(b) Speculative trading permits the transferring of this 
burden from ordinary owners, e. g., millers, to a special class. 

Illustration : A milling company buys 10,000 bu. of wheat on 
the Chicago exchange, said wheat to be delivered at once for use 
in the milling business. But the milling company wishes to con- 
fine itself strictly to its own business — milling — avoiding all spec- 
ulation in wheat. It therefore wishes to shut out any chance 
of loss by a fall in the price of wheat and flour between the 
purchase of the wheat and the sale of the flour made from it. 
Accordingly, it sells 10,000 bu. for future delivery; i.e., agrees 
to deliver 10,000 bu. at a definite price three months from date. 
This having been done, whatever change takes place in the price 
of wheat, the milling company will neither gain nor lose; that is, 
whatever it gains or loses on the original purchase of cash wheat 
will be exactly offset by an equal loss or gain on the future sale. 

Thus, suppose that, when the purchasers made, cash wheat 
is $1.00 per bu. and three-months futures $1.04. Further sup- 
pose that, when the three months have passed, wheat is $1.04. 
Under these conditions the two transactions will come out as 

follows : 

CASH WHEAT. FUTURE. 

Original cost $10,000 Cost .$10,400 

Storage, insurance, etc. 400 

. Total cost $10,400 

Value 10,400 Selling value 10,400 

Gain or loss $00,000 Gain or loss $00,0€0 

260 



CHAPTER XL CASES OF PRODUCTION. 

Evidently in this case there is neither gain nor loss from the 
transactions. 

Suppose, now, that the price at the time of future delivery 
turns out to be $1.00; will the result be dififerent? 

CASH WHEAT. FUTURE. 

Total cost $10,400 Cost $10,000 

Value 10,000 Selling value 10,400 



Loss $ 400 Gain $ 400 

Sill again, suppose price to be 90c. at time of future delivery; 
what result? 

CASH WHEAT. FUTURE. 

Total cost $10,400 Cost $ 9,000 

Value 9,000 Selling value 10,400 



Loss $1,400 Gain $1,400 

Finally, suppose price at time of future delivery to be $1.10; 
what result? 

CASH WHEAT. FUTURE. 

Total cost $10,400 Cost $11,000 

Value 11,000 Selling value 10,400 



Gain $ 600 Loss $ 600 

Thus on any price the element of risk from price changes 
is eliminated. 

Illustrative Problems. 

A Liverpool miller buys through a Duluth commission house 
30,000 bushels of wheat, paying 93 cents a bushel, and at the 
same time sells 30,000 bushels for May delivery, the price being 
95^ cents. 

(a) Assuming that 2^ cents covers the cost, (storage, in- 
surance, and interest) of carrying the wheat from the date 
of purchase till May, show that the miller will lose nothing 
on the wheat even if by May the price should fall to 70 cents. 

(b) Would he gain if the price should rise to $1.10? Prove, 
(e) What did the word "carrying" in the second sentence of 

the problem mean? 

II. Speculative Trading in Stocks and Bonds. 

Besides the speculation in produce just considered, there is, 
of course, speculative trading in stocks and bonds, i. e., in the 
shares of corporations and the notes which they have given to 
capitalists in exchange for loans. The markets where such 

261 



PRINCIPLES OF ECONOMICS 

trading is carried on are known as Stock Markets. They are 
conducted like wheat exchanges, with open trading, abundant 
competition on both sides, speculative trading, etc. Much that 
is to be condemned appears in their conduct. But they are 
after all productive institutions. They play useful, almost indis- 
pensable, roles in the economic order. Their most important 
function is to render more efficient the capital of the country. 

(a) They make investment easy. 

(b) They make withdrawal from an investment easy, and, 
in so doing, make capitalists more disposed to invest. 

(c) They bring together all classes of investments, make 
clear their disadvantages, and so appeal to all classes of in- 
vestors, e. g., those who wish above all security; those who 
demand a chance for large returns ; those who can wait in- 
definitely for returns of any sort, etc. ; 

(d) They make the properties represented in stocks and 
bonds perfectly available as a basis for loans. (Banks will 
readily accept such bonds and stocks as security, seeing that 
there is a continuous and unlimited market where these prop- 
erties can be disposed of at almost any moment.) 

(e) It is worth noting that the stock market furnishes gov- 
ernment with the best available clue to the value of corporate 
properties when these are needed for the purposes of taxation or 
social control. 



262 



CHAPTER XII. 

THE PRESENT SYSTEM OF DISTRIBUTION. 

It is a fact of everyday observation that the economic in- 
comes enjoyed each year by different persons or famiHes are 
very unequal in amount. It is an even more conspicuous fact 
that the totals of accumulated wealth owned by different persons 
or families are very unequal in amount. This inequality of 
incomes and possessions would, like any other notable phenom- 
enon, demand scientific explanation, even if no great human in- 
terest were involved. But, since such inequality is one of the 
most trying facts of actual life, its study and discussion inevitably 
becomes of quite exceptional interest and importance. Accord- 
ingly, the economist has in every generation, and in ours most 
of all, spent much time trying to answer questions like these: 
What are the incomes received by different classes of persons? 
Under what general and specific principles are these incomes at 
present determined? Is the general result entirely reasonable or 
just? If not, what is to be said for and against the various 
projects brought forward to improve matters? Such questions 
as these suggest pretty fully the scope of that division ol 
economics commonly known as Distribution. In the present 
chapter our task will be to study the facts of the existing 
system of distribution and the principles regulating them. 

Section A — The Principal Sources or Kinds of Incomes. 

Incomes naturally fall into two main classes, (a) Economic, 
and (b) Non-economic. Under the former are included all 
which arise directly out of economic activities ; e. g., wages from 
the sale of labor, or rent from selling the use of land. Non- 
economic incomes are all those which arise outside economic 
activities; e. g., from gift or theft. In some cases, the same 
income can be with more or less reason assigned to either class. 
Thus, many of the great incomes obtained in America from the 
exploitation of natural resources, such as lumber, copper, oil, 
etc., which may be classified under one of the regular economic 

263 



PRINCIPLES OF ECONOMICS 

shares — profits, — may also be conceived as in a sense non-eco- 
nomic in that they often have their origin in the foolish or 
corrupt munificence of government. It is hardly necessary to 
say that our study of incomes will be largely concerned with 
those which can properly be called economic. 

The economic incomes naturally fall into two classes : per- 
sonal incomes, i. e., incomes received in exchange for personal 
services and property incomes, i. e., incomes received in ex- 
change for the services given by some property belonging to 
the receiver of the income. Practically all important cases of 
personal income may be brought under the category of wages, 
though in ordinary speech remuneration for the higher forms of 
personal service is usually called salary. Property income gives 
three cases : rent, interest and profits. 

Rent, as commonly understood by economists and as used 
in the present course, does not correspond to the popular 
usage, which makes it to mean the hire paid for the use during 
some agreed upon period of any material object, e. g., a house, a 
piano, a boat, etc. Rather, we confine it to hire paid for the 
use of land. Even here further qualification is needed. In the 
strictest sense, rent is paid for the use of non-producible or 
anyhow indestructible elements in land. No doubt, as we have 
often had occasion to say, one sometimes has difficulty in drawing 
lines with precision. Whether a particular element in a par- 
ticular income ought to be included under rent or under some 
other categor}^ can not always be determined. But practically 
no great difficulty is experienced save in the semi-metaphysical 
controversies of economists. When governments set about tax- 
ing true rents while letting the hire of capital goods such as 
houses, barns, fences, etc., go free, they easily reach a result 
accepted by the public as substantially fair. 

Interest, we remember, is the capitalist's remuneration for 
waiting. Its purest form is seen in loans where risks are prac- 
tically eliminated. Profits, on the other hand, are the remun- 
eration paid specially for taking the risks, or better, taking the 
responsibilities of ownership.^ 

Illustrative Problems. 

1. In latter years many city governments have introduced 

* For a fuller account of the nature of profits see Section H. 

264 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

the plan of putting specially heavy taxes on economic rent or, 
what amounts to the same thing, on the value of sites. 

(a) Do you see any way of distinguishing the value of the 
site from that of the building? 

(b) Show_ that taxing the value of the site would naturally 
amount to taxing the economic rent. 

2. Mr. Crane puts $3000 into a grocery business and works 
himself in the store from morning till night. His net return 
from the business is $1500. 

Make an imaginary distribution of this income into the sev- 
eral economic shares which are probably involved, 

3. My friend has eight houses and lots in Ann Arbor which 
he rents, getting for each, let us say, $360 a year. Try to 
break up this sum into the different elements which probably 
enter into it. 

4. At a certain inland resort rowboats are let at $1.50 per 
day. Enumerate the different elements entering into this sum. 

5. The following are among the chief manifestations of the 
Interest phenomenon. Explain and illustrate each of the three 
cases under (b). 

(a) In loan contracts. People borrowing money return 
an equal sum and also something additional, — a bonus or pre- 
mium. 

(b) In the determination of prices. 

(1) Producible goods sell for prices higher than their cost in 
other goods and labor would seem to warrant. 

(2) The annual uses of producible goods sell for prices higher 
than the prices of the goods themselves would seem to warrant 

(3) Non-producible goods sell for prices lower than the sums 
of the prices of their uses would seem to warrant. 

Section B. The Influence of Legal Arrangements on Dis- 
tribution. 

It has commonly been admitted that legal conditions play a 
very large part in determining the distribution of incomes and 
possessions. The point is so evident as to need little elabora- 
tion. For example, the law commonly excludes force and fraud, 
and it is manifest that distribution depends not a little on the 
extent to which these restrictions on conduct are enforced. So, 
the law determines how far men shall be free to give away or 
bequeath property, and so determines in no small measure the 
size of incomes having such origin. Again the law decides 
whether private individuals shall have a property right in other 
men, in land, in capital goods, and so on ; and the decision 
reached in each of these cases has a great influence on distri- 

265 



PRINCIPLES OF ECONOMICS 

bution. If private persons were prohibited from acquiring and 
holding the title to land, rent, as a share enjoyed by a limited 
number of private persons, could hardly exist. Similarly, inter- 
est and profits, as private shares, depend on the right of private 
property in capital, also on the right of business initiative, on the 
right to exchange present goods for future goods plus a bonus, 
and so on. Still again, the law can greatly modify distribution 
through its use of the taxing power. The burden of supporting 
the state may all be thrown on the wealthy class, or on a lim- 
ited section of that class, e.g., the landowners. Further, the 
state, while locating the burden of its support on a special class, 
may greatly expand its activities for the economic benefit of some 
other class or classes, thus in effect redistributing incomes. 

Illustrative Problems. 

1. By substituting public for private ownership of land, the 
state would do away with rent as a private income. 

(a) Would it do away with rent altogether? 

(b) Would it make the land any freer than it is today, i.e., 
would it make the process of getting hold of a piece of land 
from which to make a living easier or cheaper for the poor 



man 



2. Socialism would try to get rid of interest as an individual 
share. Could it probably annihilate interest altogether? 

3. If the laboring classes were in a condition of true slav- 
ery, would there be wages in the strict sense of the word? In 
any sense of the word? 

4. "After the tax (land tax) has been in force for a num- 
ber of years, * * * it ceases to impose any burden whatever 
upon the present landowners. Hence a government which fails 
to raise the rate of the land tax every few years discriminates 
in favor of landowners." 

Give the argument by which the above contention is sup- 
ported. 

5. "The use of indirect taxes to raise the public revenue 
exaggerates the inequalities of a system in which inequalities 
are already far too great ; for such taxes rest with much greater 
weight on the poor than on the rich." Explain the argument for 
this contention. 

Section C. General Character of the Process whereby the 
Regular Economic Shares are Determined. 

Generally speaking, the process whereby the regular economic 
incomes — wages, rent, interest, and profits — are determined is the 

266 



CHAPTER XIL SYSTEM OF DISTRIBUTION. 

price-determining process. In other words, distribution may 
quite properly be conceived as only a subdivision of exchange, 
or anyhow as regulated by the laws of exchange. The correct- 
ness of this account of the matter is easily established by run- 
ning over the several types of economic income. Thus (a) it is 
manifest that wages of all sorts are in most cases nothing but 
prices, i.e., the prices of labor services brought by the laborer 
to market, (b) Interest is also a plain case. As we have con- 
ceived it the lender makes a sale, a sale of the service of wait- 
ing. In that way of putting it, interest is plainly a price. If 
one prefers the form of expression which describes the lending 
transaction as an exchanging of present for future goods plus a 
bonus, we still make the case one of exchange — and so of values, 
(c) Rent is obviously the price of something, i.e., the use of 
land unmodified or modified only by improvements which are 
indestructible, (d) The case of profits is, on the surface, less 
evident; but, at bottom, it is not materially different. The 
entrepreneur supplies the service of responsibility-taking. From 
the very nature of this service, it can not be sold directly; but it 
is virtually sold in that the entrepreneur unites this service with 
the services which he buys from other agents in the productive 
processes and sells the total resultant on the general market. 
Profits, therefore, are in effect a price received for a service 
supplied. 

The preceding discussion shows that incomes are directly 
determined under the principles of exchange. There is another 
less direct, but not unimportant, sense in which incomes are de- 
termined through exchange processes. The immediate income 
which most of us get is an income of money or its equivalent. 
To realize our income we turn this money income into com- 
modities or services through exchange. But, obviously, the 
amount of the latter which we enjoy must depend in large 
measure on the money prices of these commodities and services. 

Section D. The General Principle Determining the Regular 
Economic Incomes under Free Competition. 

We have just seen that the regular economic incomes are 
either themselves prices, — wages, rent, interest, — or anyhow are 
dependent on the prices of other things, — profits. Further, the 
student has probably noted already that the incomes in question 

267 



PRINCIPLES OF ECONOMICS 

are really nothing more than the prices or values of those ulti- 
mate cost goods discussed in Section G, Chapter IX. It follows, 
therefore, that the principle there set forth as determining the 
values of the ultimate cost goods is really the general prin- 
ciple which in the long run governs the regular economic in- 
comes. For various reasons I shall here present the principle 
in slightly modified form. 

Principle. — Every economic income tends to approximate that 
qnantity of goods which constitutes an expression* of the mar- 
ginal utility (productivity) to people at large of the actual out- 
put — when competition is free, the natural output — of the type 
of service rendered by the receiver of said income, and which 
also, in the case of free competition, constitutes an expression 
of the net marginal disutility, original or derived, involved ' in 
furnishing said type of service. 

Explanatory Comments. 

(a) The above principle is really a compound one, in that 
it asserts the coincidence of income both with the marginal 
utility and the marginal disutility attaching to the service rendered. 
The full title of the principle, therefore, would naturally be 
the Utility-Disutility Principle. It is possible, however, to treat 
the two parts as separate principles; and this is perhaps desir- 
able at times in that the first is accepted by some writers who 
would stick at the second. Again, the first of the two prin- 
ciples, the utility one, is more often designated the Productivity 
Principle, because of the fact that the great majority of ultimate 
services are devoted, not to supplying utilities directly, but to pro- 
ducing other goods which supply utilities directly. This practice 
we shall usually follow whether referring to the principles sep- 
arately or jointly considered. That is, we shall speak of the 
Productivity Principle, also of the Productivity-Disutility Prin- 
ciple, though not binding ourselves to exclude references to the 
Utility Principle. 

Another designation which will frequently be given our prin- 
ciple is : The Service-Value Principle. This is intended to 
bring out the fact that, according to the principle, each person 



*This is the strictly exact method of stating the point; but it is too roundabout 
for practical needs. Hereafter we shall usually say equals or approximates marginal 
significance or utility. 

268 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

tends to receive a share which represents the value of his serv- 
ice or contribution. 

(b) We have just seen that the formula above set forth 
really contains two principles in one. It should further be noted 
that the first of these is itself compound. It says that each 
income tends to approximate the marginal productivity of tlie 
actual output, while, under free competition, it tends to approxi- 
mate the marginal productivity of the natural output. That is, 
shares correspond to marginal productivity anyhow, — even when 
monopoly prevails — ; but, then, this is the marginal productivity 
of an artificially restricted output or supply. If we have free 
competition, the marginal productivity involved is that of the 
natural output — the output which would be expected in view of 
the disutilities incurred. 

(c) The principle does not say that the income tends to 
equal the marginal significance of the type of service furnished, 
but that it tends to approximate that sum. That is, marginal 
utility and marginal disutiHty constitute limits within which the 
economic shares naturally range. They can not be above mar- 
ginal utility nor below marginal disutility, — the former is the 
buyer's maximum, the latter is the seller's minimum — ; but they 
do not necessarily coincide with either. Thus (1) even in the 
case of limited stock goods, e.g., the use of land, where cost 
plays no part, value is fixed, precisely speaking, not at marginal 
utility but at some point ranging from marginal utility down to 
but not including the first sub-marginal utility; and, if these 
two utilities are somewhat widely separated, value may vary 
considerably under the same conditions of demand and supply. 
For example, let us suppose that there are 12 sites of a certain 
grade, and that a section of the demand schedule for the use of 
these sites runs as follows: 7 wanted at $550 or any figure be- 
low ; 2 more wanted at $520 or any figure below ; 3 more wanted 
at $500 or any figure below; and 3 more wanted at $440. Under 
these conditions rent could be $500 or any figure down to, but 
not including, $440. That is, rent would only approximate the 
marginal utility, not equal it. Again, (2) in the case of pro- 
ducible goods, there is another element contributing uncertainty. 
Cost may play a part. If the marginal cost (disutility) lies 
between the marginal utility and the first submarginal utility, then 
the value or price may be anything from marginal utility down 

269 



PRINCIPLES OF ECONOMICS 

to, and including, marginal cost. And, since the distance be- 
tween them might be considerable, we could only say that price 
must tend to approximate each. (To get clearly in mind this case 
of a price ranging from marginal utility down to marginal cost, 
turn to Problem 12, p. 232. Combine output schedule A with the 
demand schedule, and you will have a price determined in the 
way described, save that in Distribution we have to do with 
disutility costs rather than with money costs.) 

(d) The principle as stated teaches that each tends to get 
the sum which represents the marginal significance of his serv- 
ices. It is possible that a given laborer may be supplying a 
service for which the buyer would be willing to pay $10, though 
he only needs to pay $3, because the latter sum expresses the 
marginal utility of this type of labor-service. This is, of 
course, the same principle that we have in the case of ordinary 
goods, bread, meat, coffee, and so on. Whether ethically right 
or wrong, there is nothing peculiar about it. 

(e) In the second part of our principle, it was said that 
every economic income tends to be one which constitutes an 
expression of the net marginal disutility, etc. The word "net" 
was introduced to provide for the following feature of the 
matter. In not a few cases, the supplying of a given service 
involves advantages as well as disutilities ; e.g., university teach- 
ing gives men opportunity for the pursuit of scientific investi- 
gations, practicing law gives men standing in the opinion of 
their fellows, and so on. Now, it is evident that, in cases of 
this sort, the reward received by the man who supplies the 
service does not need to be large enough to express the full 
disutility of his task but only large enough to express that dis- 
utility minus the incidental advantages of the calling. 

(f) In the second part of our principle it was said that 
incomes tend to approximate the marginal disutility, original or 
derived, etc. By an original disutility we mean one that attaches 
to the supplying of some service by the very nature of the case, 
e.g., the weariness and pain, which from the first accompany 
excessive labor. By a derived disutility we mean one which does 
not belong to the supplying of a service at the outset but comes 
to attach itself to said supplying of a service because of later 
developments. Here we have in mind the case of supplying 

270 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

land services. It is almost self-evident that doing this does not 
involve an original disutility. Originally the land costs nothing. 
Supplying it involves in the first instance no sacrifice. But this 
is not the end of the matter. The inevitable working of the 
principles of value develops a sacrifice cost for supplying land 
services. When through the growth of demand, a piece of 
ground hitherto worthless, comes to yield a net income of $100, 
it inevitably takes on a value of, say, $2000 ; so that any person 
other than the present owner who should desire to get the right 
to this $100 income would have to pay for such right $2000. In 
short, to him the land would present itself as so much capital 
goods yielding 5 per cent as a payment for the abstinence or 
waiting involved. Here we have sacrifices which are necessarily 
undergone in connection with the supplying of land services, 
and which, therefore, must be recognized as disutility costs. 
Still they, obviously, are not primary, original, costs like labor 
and waiting, but only secondary, derivative, costs. 

(g) The reader's study of the forces and processes deter- 
mining normal price in the case of ordinary goods will prob- 
ably safeguard him against a not uncommon misunderstanding or 
misapplication of the principle before us, which runs like this : 
"You economists are always teaching that, if there is free 
bargaining between laborers and capitalists, the former will get 
all they produce." In answer, I hardly need say that it is not 
primarily freedom of bargaining between laborers and capital- 
ists, but rather freedom of competition among capitalists (entre- 
preneurs) which we expect will insure that laborers get sub- 
stantially what they produce. 

(h) Finally, it must not be supposed that, in affirming that 
the present system tends to give each one what he produces, we 
mean to claim that the present system is necessarily a just one. 
Thus, a man's power to contribute to the social welfare depends 
on his right to dispose not only of his own services but also 
of the services of some products or some land which he controls. 
But, obviously, it may be wrong to allow him to have the dis- 
posal of the services of products and land. 

Argument for the General Truth of the Principle. 

As was brought out in Section G, Chapter IX., the problem 
now before us, i.e., the problem as to how the regular eco- 

271 



PRINCIPLES OF ECONOMICS 

nomic incomes are determined, is almost identical with the prob- 
lem treated in that connection, i.e., the problem as to how the 
prices of the ultimate cost goods are determined. Further, it is 
hardly necessary to say that the solution reached for our earlier 
problem is substantially identical with that solution of our pres- 
ent problem, which is embodied in the Productivity-Disutility 
Principle just set forth and explained. Accordingly, it would 
seem legitimate to assume that our principle has already been 
established; and this we will do, although, in discussing some- 
what more fully particular incomes, we shall probably offer, 
incidentally, some further defense of the doctrine. 

Section E. Corollaries of the Productivity Principle. 

It hardly need be explained that no one, in affirming the 
truth of the Productivity principle, means to teach that it is 
precisely realized in the phenomena of actual life. Few con- 
tributors to production receive sums which exactly correspond 
to their contributions. Some get much more ; a far larger 
number get less. But, again, it is hardly necessary to say that 
the case of the Productivity principle is not materially different 
from that of any other economic law. Those hypotheses which 
are assumed as the starting point of all economic reasoning, viz., 
absence of force, fraud, favoritism, monopoly, and other con- 
ditions interfering with freedom of competition and contract — 
are far from being realized. Further, were none of these man- 
ifestly abnormal elements present, we should still have human 
ignorance, folly, inertia, and so on, to hinder any precise real- 
ization of the economic principle under consideration, as in fact 
of any other economic principle. But, while the principles of 
economic science are nowhere rigidly operative, they are so far 
dominant that they can not in practical affairs be safely ignored. 
Looked at broadly, economic phenomena are under their control. 
While this statement is more conspicuously true of some other 
economic principles than of the one before us, still, it applies 
to this one also. Not a few well-meant but ill-directed reforms 
have been thwarted because of a disregarding of this principle. 
This point, however, is best brought out by presenting some 
corollaries. 

Corollary 1. Attempts to iix arbitrarily the amount of any 
economic share whether by governmental or private action with- 

272 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

out changing the demand for, or the supply of, the particular 
type of service involved can succeed only within the narrowest 
limits. 

Illustrations of such attempts: Statute of Laborers (1351), to 
keep wages at the old level in spite of the diminution of labor- 
ers through the black death ; minimum wage laws ; usury laws. 

Note that the attempts which the corollary deals with are 
attempts arbitrarily to regulate the value of something without 
changing demand or supply. It is at times possible arbitrarily to 
change prices, but only on condition that one accepts the con- 
sequences in the shape of changed demand or supply. Thus, a 
monopolist may arbitrarily raise his price, but only on condi- 
tion that he reconciles himself to* smaller sales. So the work- 
men in a particularly trade, if very strongly organized, may 
put up the wages of their trade,, but at the same time they 
must be content with fewer jobs. So, again, if government in- 
sists on establishing a maximum price for some producible serv- 
ice below the cost of supplying that service, it will have to be 
satisfied with seeing the supply of said service fall off. If -in 
any particular case the action taken to fix prices can not alter 
demand and supply conditions, it can seldom succeed at all. 

Argument. The corollary before us really contains two 
elements: (1) An admission that the shares can be, in some 
degree, fixed arbitrarily by legislation, and (2) A claim that 
this is possible only within very narrow limits. Let us begin 
with the first point. 

A. Some arbitrary iixing of the shares is possible. (1) A 
share can always be fixed within the limits set by the Produc- 
tivity-Disutility Principle, as against any fixing of it at a point 
outside those limits because of a failure of competition or the 
intervention of any illegitimate element. For example, rent is 
not seldom driven above marginal productivity because of the 
ignorance or inertia of tenants; and government can bring it 
down to the proper level without colliding with regular eco- 
nomic forces. (2) It is probable that there is nearly always 
some leeway between the marginal utility and the first sub- 
marginal one and between the marginal disutility and the first 
supra-marginal one, i.e., our principle fixes, not the precise amount 
of each share, but only the limits within which it may range. 
But one point within these limits will reconcile supply and 

273 



PRINCIPLES OF ECONOMICS 

demand as well as another. Hence, within these limits, legisla- 
tion can arbitrarily fix on one particular point rather than 
another without coming into collision with regular economic 
forces. For example, if wages anywhere frorn $1.20 to $1.40 
would ; reconcile demand and supply, the law might fix them at 
$1,40 without contravening our principle at, all. (3)ilt is ad- 
mitted -that the prices of labor services or capital services or 
land services can be fixed, at points somewhat outside the limits 
set by the Productivity-Disutility principle because of the inertia 
or weakness of buyers or sellers of those services. But, this 
being true, it is surely reasonable to claim that government, 
when public policy demands it, can take advantage of similar 
weaknesses to fix prices somewhat outside the limits fixed by our 
principle. 

B. Such arbitrary Uxing of the economic shares is possible 
only within very narrow limits. (1) Law can not long compel 
people to pay for anything more,— anyhow much more, — than it 
is worth to .them. (2) Law can not long hinder people from 
paying for anything as much, — ^anyhow almost as much, — as it is 
worth to the. marginal buyer; for this is the only way to insure 
that buyers at or within the margin will get the goods, as against 
buyers outside the margin. (3) Law can not long compel people 
to furnish anything for a price much below that which expresses 
to them the disutility incurred in furnishing that thing. (4) Law 
can not long hinder people from taking a price for some serv- 
ices, substantially as low as that one which expresses the dis- 
utility incurred in furnishing said service. 

Corollary 2. Broadly speaking, the share per unit of each 
class of producing agencies varies inversely as the size of that 
class: 

Abundant land makes rent low ; abundant capital makes 
interest low; abundant labor makes wages low. This obviously 
results from the joint action of the principle of productivity and 
the law of diminishing returns. Each productive agent tends to 
get an amount equal in value to what the marginal member of 
his clkss produces. But, since the larger his class the smaller 
will be the product of the marginal member, therefore the 
larger his class the smaller the income which each member gets. 

Caution :— Remember that every scientific principle assumes 

274 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

continuity of conditions. An increase in the volume of capital 
would not necessarily lower the rate of interest if accompanied 
by the introduction of new and more efficient methods of em- 
ploying that capital. 

Corollary 3. Broadly spmking, the share per unit of each 
class of producing agencies varies directly as the size of. other 
classes which co-operate with it. . • 

If capital increases in volume, not only does the rate of re- 
turn to capital tend to fall, it is equally true that the rate of 
return to labor and land also tends to rise. 

Argument. A. That increasing the size of one class increases 
the share of the others, (l) According to the last corollary, 
the condition supposed lowers the rate of return to the chang- 
ing factor. (2) Since the total going to said changing factor 
out' of the product of earlier units of the combination is fixed 
by multiplying the number of units into the rate, said total will 
be smaller than before. (3) In consequence the portion of the 
product of earlier units going to the other factors, being that 
product minus the total going to the changing factor, will be 
larger than before. Illustration': Ignoring capital, let us sup- 
pose that a certain piece of land will yield to one man's labor 
14 bushels of wheat ; to the labor of two men, 20 bushels ; to 
that of three men, 24 bushels ; and to that of four men, 26 
bushels. When, now, laborers are so few that land needs to be 
worked in the first stage only, the whole product, 14 bushels, 
will go to labor. When it becomes necessary to put on a 
second mian, he will add only 6 bushels, therefore will get only 
6 bushels, and the iirst man also will get only 6 bushels, thus 
giving the landlord 20 minus 12 or 8 bushels rent. So when a 
third man has to go on, his product and share will be 4 bushels ; 
the shares of laborers 1 and 2 will fall to the same figure, and 
the total of the landlord will become 24 minus 12, or 12 bushels. 
Thus, increasing the number of laborers lowers their share and 
raises that of the landlord. 

■- '' B. That diminishing the size of one class diminishes the 
shares of the others. Here the proof merely reverses the 
preceding. Let the student work it out for himself. 

•^ Corollary 4. Increase of population in itself tends to lower 
all shares hut rent, most of all wages. 

275 



PRINCIPLES OF ECONOMICS 

This is an evident corollary from the preceding proposition. 
Increasing population means, in general, lowering the margin 
of industry, bringing into use lower grades of land ; since land 
as such is non-increasable. Hence the marginal return to land 
i. e., the portion of the total which goes to the human factors 
in production, labor, waiting, and risk-taking must, in the 
absence of new conditions, tend to decline. The lowering 
tendency is greatest in the case of wages, since a normal 
increase in population tends to increase the supply of labor 
more than that of waiting or risk-taking. 

Note 1 : — It is sometimes argued that increase in population 
does not lower wages for the reason that each person brings 
into the world capacity to produce as well as capacity to con- 
sume. He adds, therefore, to the supply of goods just as much 
as to the demand. This merely shows that there is not ordin- 
arily any danger that the new laborers will be unable to get 
any wages at all. It does not show that they will be able to 
get as high wages as before. Since the stock of natural factors 
in production and the stock of capital are not increased by 
the incoming of the new laborers, therefore the marginal 
productivity of labor, and with it the wages of labor, must 
tend to be lowered. 

Note 2 : — It is sometimes argued that increase in population, 
in that it makes a larger market and so justifies the resort to 
extreme specialization, large scale production, etc., really raises 
marginal productivity rather than lowering it, and so raises 
the shares going to labor and capital. This is doubtless 
possible, but not in my opinion, probable. In most counines 
population has long since reached the size which would justify 
a resort to the most efficient methods. If a particular community 
is failing to take advantage of the possibilities of large-scale 
production because markets are too small to justify a resort 
to that method, this smallness of the markets is probably not 
due to the lack of the population necessary to make a large 
market, but to the lack of those facilities for transportation 
and communication in general which are necessary to coalesce 
the different small markets into one large one. 

Corollary 5. Any cause which restricts competition among 
the persons who supply a particular type of service tends to 
increase the rate of income received by the said persons. 

It is of course a fact familiar to the student that producers 
in all lines are disposed to adopt measures to limit competition, 
each in his particular line. Monopoly in some form or degree 
is a condition of things which consciously or unconsciously 
almost every one tries to see realized in his special field. Per- 

276 



CHAPTER XII. SYSTEM OF DISTRIBUTION, 
haps the entrepreneurs in some industry, e. g., sugar produc- 
tion, form a trust, thus establishing a combination zc wide- 
reaching as to approximate monopoly. Or perhaps the men 
engaged in building houses in a particular city'form an agree- 
mient whereby they promise not to compete in the fullest sense 
against each other. Or perhaps the painters combine to restrict 
their numbers by refusing to take on more than a fixed num- 
ber of apprentices at any one time. Now, it is doubtless hoped 
in each of these cases that the action described will increase 
the returns to the persons interested ; the entrepreneurs , in 
sugar and the contractors will get larger profits, and the work- 
men in the case of painting will get larger wages. Further it 
is doubtless true that the result thus hoped for is largely realized. 
Such restrictions of competition do usually increase the incomes 
of the persons interested. The reasons are plain. Diminished 
competition means decreased output, therefore higher marginal 
productivity or utility, therefore higher price for the service 
involved. The principle as stated says "rate of income" rather 
than simply "income" in order to provide for cases where re- 
stricting of output might increase the return per unit of service 
performed but not per person. Thus, the whole body of labor- 
ers might unite to keep, say one-fifth of their number idle, 
hoping thereby to increase the total income of their class* ; 
while in fact they might thereby lower the total though increas- 
ing the rate, i. e., the income per unit of service or effort. 

Corollary 6. Any cause which restricts competition among 
the persons who supply a particular sub-class of services tends 
to lower the incomes of the persons who supply related sub- 
classes of services. 

Example. Restricting competition among painters tends to 
lower the wages in inferior trades. 

As we have seen, it is very common to try to limit the out- 
put of one's own type of service in order thereby to raise the 
price of it. It is less common, but by no means rare, to hear 
persons who have inaugurated this policy attempting td enlist 
the sympathy and support of others as if the public in general 



*It probably can be shown that as a mere matter of, economic, theory, 
this is a possible result. It does not, however, seem of sufficient importance 
to reward the effort. I will perhaps insert a discussion of' the matter in 
the next edition of the Readings. . ' , x. 

277 



PRINCIPLES OF ECONOMICS 

or producers in general were to gain by it. That persons some- 
times succeed in this attempt does not alter the facts of the 
case. Their position is, generally speaking, quite untenable. 
We may sympathize with their aims, may even be glad to suffer 
some loss in helping them to realize those aims ; but we are 
bound to experience a loss — the policy in question is against 
the immediate economic interests of all but the persons directly 
concerned. 

Argument. Restricting competition within any sub-class of 
productive agencies drives the persons shut out of that sub-class 
into related sub-classes, thereby increasing the size of said sub- 
classes. As a consequence, under the working of corollary 2, 
the share per unit of those classes is lowered. 

Corollary 7. Broadly speaking, all causes tending to increase 
tJie efficiency of laborers, e.g., education, manual training, in- 
creased physical vigor, etc., tend also to raise wages. 

An obvious corollary from the Principle. 

Corollary 8. Broadly speaking, improvements in method 
through discovery and invention tend more especially to increase 
interest and profits. 

Such improvements increase the marginal productivity of 
waiting and risk-taking, and so fulfill the conditions of the 
Principle. 

Note : — This is not to say that improvements in method 
bring no advantage to laborers ; — but this advantage comes 
indirectly in lowered prices and so larger real wages. 

Corollary 9. The normal income for a laborer of any partic- 
ular class tends to approximate the income needed to maintain 
said laborer in accord with the standard of living looked upon 
as necessary by this particular class of persons in the particular 
time and place. 

Note 1. This principle is commonly stated as if applicable 
only to rnen who labor with their hands, or even, among these, 
only to the lower or lowest types. In fact, it is true of all 
classes, even professional people. 

Note 2. As applied to common workmen, this principle 
should be sharply distinguished from the "iron law of wages" 
commonly, but erroneously, attributed to the classical economists. 
That theory affirms that the wages of common laborers tend to 
equal the bare or necessary cost of subsistence, — no allowance 

278 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

being made for what people look on as necessary to a decent 
living. 

Argument. A. The case of the professions and other types 
of labor above the lowest.- (1) An income below the standard 
of living income can not be maintained; because persons in 
these classes have always as an alternative dropping into some 
lower class. This they will do if incomes fall below the recog- 
nized standard, — with the result that the supply of the services 
involved will fall off, their marginal utility will rise, and so their 
price will rise. (2) An income materially above the standard 
can not long be maintained, because it will cause an influx from 
other closely related callings, which will lower marginal utility 
and so lower price (wages), 

B. The case of common labor. (1) An income below 
the standard can not permanently be maintained, because it will 
hinder marriage, hence cut down the supply of labor, therefore 
raise its marginal utility and so its price. (2) An income above 
the standard will, of course, tend- to have the opposite effect, 
increasing population, lowering marginal utility, and so lowering 
wages. 

Comment. It is an evident deduction from the corollary be- 
fore us that in the long run^, the rate of wages can be changed 
by changing the ideals of working men. But it hardly need be 
remarked that emphasis must be laid on the phrase "in the long 
run." Of course, it is not possible for a particular generation 
of laborers to raise wages, if these are already as high as the 
marginal productivity of labor, simply by resolving to live better, 
to spend more. The setting of a higher standard of living can 
influence wag^es only in so far as it restricts population and, so, 
raises the marginal productivity of labor. It naturally follows 
from what has just been said, and it has always been recognized 
by economists that it is possible for adverse conditions to hold 
actual wages below the standard until the working classes in- 
sensibly come to accept this lower wage level as a new standard. 
On the other hand, favorable circumstances may work the op- 
posite result. In short, a new level of wages brought about, and 
for some time maintained, by temporary causes tends to persist. 
(Well treated by Malthus, McCulloch, and Walker.) 

Illustrative Problems. 

1. The following table contains corresponding sections from 
hypothetical output and demand schedules of a certain type of 
labor. On the basis of this table, answer the questions follow- 
ing: 

279 





Utility (or) 




Output 


Disutility 


Demand 


hours 


cents 


hours 


700 


40 


100 


400 


35 


120 


280 


30 


140 


200 


25 


200 


140 


22 


250 


120 . 


20 


400 


100 


18 


500 


. 80 


15 


800 



PRINCIPLES OF ECONOMICS 

(a) What would wages per 
hour tend to be? 

(b) How much is marginal 
utility? average utility? 

(c) What do you mean by 
marginal utility in this case? 

(d) How much is marginal 
cost or disutility? average cost? 

(e) What is meant by marginal 
cost or disutility here? 

(f) Which determines wages? 
Why do you think so ? 

2. Suppose the schedules in Problem 1 be changed to read as 
follows; 

(a) What different rates of 
wages might prevail? 

(b) What would be the margi- 
nal utility of labor under each? 

(c) What the marginal disutil- 
ity? 

(d)What would fix the limits 
of variation? 

(e) By what process would 
the rate be finally determined? 

(f) Change the demand figure 
at 25 and 24 cents from 240 to 
2G0, and answer questions (a) 
to (e). 

(g) Change the output at 29 
cents from 200 to 280, and 
answer questions (a) to (e). 

3. If competition were in the highest degree free, which of 
the above schedules, that of Problem 1 or that of Problem 2, 
would, more probably express the facts of life? Give reasons. 

4. Suppose that at a certain date, competition being free and 
general conditions normal, the rate of wages for ordinary labor 
is $1.50 per day; and suppose, further, that, under these condi- 
tiatis, the legislature passes a law forbidding any one to pay 
or receive wages less than $5 per day. 

■ Do your believe that this would result in giving every one 
wageS' of $5 per day? Why? 

5. "The logic of their (the orthodox economists') teaching, 
has been that wages which were determined by free bargaining 
between capital and labor would be just or reasonable wages." 
• Point out wherein the above is incorrect, or at least inade- 
quate, -as a statement of the real teaching of the economists. 

6. , *'In a country possessed of rich and abundant natural 
resources wages would naturally be higher than in another 

280 





UtihV(or) 




Output 


Disutility 


Demand 


■hours 


V cents 


hours 


" 280 


32 


170 


„ 280 


•31 


170 


. 280 


30 


170 


• 200 


29 


200 


200 


28 


200 


: 20O 


■ 27 


200 


. 200 


'26 


200 


200 


25 


240 


150 


24 


240 


150 


23 


240 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

having an equal population but inferior natural resources^" 
Argue this out fully. 

7. "Wages are apt to be fixed much closer to the minimum 
which the laborer will take than the maximum which the em- 
ployer will pay; for the latter has much more skill and strength 
in bargaining." 

Perhaps the above is true ; but the argument given to prove 
it is by no means decisive. It is quite possible that wages should 
be kept close to the employer's maximum, in spite of the laborer's 
weakness in bargining, because the first sub-marginal utility is 
close to the employer's maximum. Explain just what this means 
and how it can be true, — constructing for the purpose schedules 
something like those which appear in Problems 1 and 2. 

8. Suppose that a certain country receives a large body of 
immigrants, amounting to, say, twenty. per cent of its laborers of 
a particular class. 

(a) Under the principle of productivity, what would tend to 
be the effect on wages? Explain. 

(b) If these immigrants brought in knowledge and skill in 
their craft far beyond that possessed by the home laborers, 
how would this immigration tend to affect wages in the long 
run ? Explain. 

9. "If the rate of interest on a certain class of loans remains 
for a long period at 5 per cent, it is reasonable to affirm that 
this figure expresses at the same time the marginal utility of a 
year's use of one dollar of capital, and the marginal disutility 
of supplying that capital." 

Construct a supply schedule for money capital and a demand 
schedule under which the rate of interest would tend to be just 5 
per cent, and would at the same time express the marginal utility 
of capital and the marginal disutility of supplying it. 

10. What bearing does corollary 9 of our principle have on 
the question whether Chinese immigration should, or should 
not, be discouraged? 

11. "If all day-laborers should agree to work with one hand 
tied behind them, would their wages go up or down? Would it 
be good or bad for this whole class of laborers?" (Fetter) 

12. One of Professor Clark's favorite phrases is "functional 
distribution." What do you suppose he means by it? 

13. What connection is there between the Law of Diminish- 
ing Returns and the contention of many writers that conscious 
restraint should be placed on the growth of population? 

14. "Formerly the workman owned the instruments with 
W'hich he worked. To-day these , instruments are all owned by 
another class — the capitalists. Now, since without instruments 
the workman's labor-power is useless, he is obliged to accept such 

281 



PRINCIPLES OF ECONOMICS 

wages ks the capitalist may dictate even though these are far 
below what his labor produces." 

(a) Show that the ownership of the instruments of industry 
by a class different from the users of those instruments does not 
of itself lead to the result indicated. 

(b) Write out an analogue to the above quotation in which 
the' capitalist and workman change places. 

15. Why is it to be expected that wages would be higher in 
the United States than in Europe? Argue the matter out on the 
b^sis of principles. 

■'16. Suppose that by the draining of swamp lands, one-fifth 
should be added to the tillable soil of the country. What effect 
would it tend to have on wages? on profits? on agricultural 
rent? Explain in each case. 

17. Suppose that land and labor of just one kind were the 
only factors in production, that land was of different grades 
'-shading one into another, that not all the land in existence was 
under cultivation, and that wheat raising was the only industry. 
Show that wages would tend to equal the marginal product of 
labor. 

18. It was generally held by the economists of the so-called 
classical school that, if the methods of production undergo no 
substantial change while population keeps on increasing, wages, 
interest, and profits will tend to get smaller and smaller and rent 
(economic rent) to get larger and larger. 

Show that this doctrine is a natural deduction from the 
theory that the shares of labor, waiting, and responsibility- 
taking are determined by their respective marginal productivities. 
' V9. ■■ "It is a mistake to suppose that competition merely keeps 
down wages. It is equally the means by which they are kept 
up." Mill. Explain. 

20. ' "No remedies for low wages have the smallest chance of 
being efl^cacious, which do not operate on and through the minds 
and habits of the people." Mill. 

, -Argue for the truth of this statement. (It probably needs 
qualification; but leave that for some other occasion.) 

21. Below is given a section of a schedule assumed to 
represent the supply and demand schedule for the use of capital : 



Sup. 


Price 




Dem. 


4.1 billions 


10% 


3 


billions 


4 


9% 


3.5 


u 


3.9 " 


8% 


4 


(( 


3.8 " 


7% 


4.5 


(( 


3.7 " 


6% 


5 


« 


3.6 " 


5% 


5.5 


ii, 


3.5 " 


•4% 


6 


It 


3.4 


3% 


6.5 


<< 


3.3 " 


2% 
282 


7 


<( 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

(a) What will tend to be the rate of interest in this .case? 

(b) What will set the limits to price variation? 

(c) Is it likely that a usury law fixing the rate of interest 
at 5 per cent would be effective? Why do you think so? 

22. Give some reasons for expecting that, under the natural 
working of the Productivity-Disutility principle, the incomes of 
university professors would be smaller than those of men hav- 
ing no greater natural endowment who are working in other 
fields, say engineering, law, or business. 

23. Discuss in a similar way the question why the wages of 
men are likely to be higher than those of women in similar 
lines. 

Section F. The Theory of Employment. 

In dealing with labor's share in distribution it has been usual 
to approach some of its problems from the standpoint of employ- 
ment. How far this procedure is really profitable one can not 
easily decide ; but in view of popular usage it seems best to 
give this phase of the matter some consideration. 

1. Employment and the Demand for Goods. 

Immediately, of course, labor is bought by enterpreneurs ; and 
so, in a sense, the amount of employment depends on the demand 
of entrepreneurs. But it is obvious that entrepreneurs do not 
want labor save as they intend to produce goods with it and that 
they are not going to produce goods save as the public demand 
them. Less immediately, therefore, the demand of entrepreneurs 
for labor — the amount of employment — is in some degree or sense 
determined by the public's demand for goods. But the public's 
demand for goods is, in the last analysis, dependent on their 
output of goods. (Say's Law). Only by producing goods can 
we create a demand for the goods which other producers, get 
out and, therefore, only by this process can we create a demand 
for the labor of the workmen who assist those other producers 
in getting out said goods. 

Principle. In so far as employment depends on the demand 
for products, it changes with, and only with, the output of 
products for the market. 

Some of the mo^t important applications of this principle 
were brought out in the problems given under Say's Law (pp. 
152 to 154), our present discussion of them, therefore, will be 
brief. . , , 

Corollary 1. The destruction of objects of wealth which are 

283 ' 



PRINCIPLES OF ECONOMICS 

bound to be replaced does not increase employment. See Read- 
ing XII. 

Corollary 2. Private expenditure for extravagances, as con- 
trasted with other forms of expenditure or even with hoarding, 
does not increase employment. 

Argument: (a) $10,000 spent in buying bread or cotton cloth 
contributes just as much to make a demand for labor as $10,000 
spent in buying fireworks or champagne. 

(b) $10,000 spent in buying 500 ounces of gold coin to bury 
ir the ground contributes to the demand for labor just as much 
as $10,000 spent on silver for plate. 

Note 1. It is possible to maintain that some forms of ex- 
penditure give more employment than others, since labor, as 
compared with capital and land, plays a larger part in some 
forms of production than in others. But economists have with 
practical unanimity held that expenditures for extravagances 
contribute less to create employment than expenditure for capital 
goods, — producers' goods — e.g., engines, machinery, etc. 

Note 2. The case of hoarding brought out in the theorem 
has merely theoretic interest. Practically, true hoarding is in 
our day a negligible phenomenon. The rich man spends his 
money (or lends it to some one who spends it) for some goods 
or other, whether it be for consumption goods or for those 
devoted to production. 

Note 3. Temporary hoarding may diminish the demand for 
labor. It will not cause an increased demand for gold and will 
diminish the demand for other things. 

Corollary 3. Governmental extravagance does not increase 
employment. 

The money taken from taxpayers would have been used to buy 
goods and, so, would have made employment, had it been left 
with the taxpayers. 

Note. 1. Of course, laborers, as consumers, may receive ad- 
vantages from governmental expenditures just as other citizens 

do. 

Note 2. Governmental extravagance may temporarily increase 
employment in a period of industrial stagnation. Here there is 
more or less temporary hoarding. See Note 3 above. 

Corollary 4. Producing for oneself, when it is done without 
decreasing one's output for the market, does not diminish em- 
ployment. 

For example, a person who produces through his property or 
his efforts or both, say, $1,000 worth of products each year 
does not diminish employment by putting in some spare time 

284 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

building himself a boat, — it being assumed that his outside 
production is not changed. 

Corollary 5. Broadly speaking, an increase in the supply of 
labor services creates opportunities for employment as well as 
absorbing them, though not usually in quite the same proportion. 

Caution. This does not mean that the process in question 
will have no adverse effect. Without doubt it will tend to cause 
some decline in the rate of wages, under the working of the prin- 
ciple of diminishing productivity. But this result is not to be 
confused with the question of employment. Besides, in not a 
few cases which receive considerable attention, the influence on 
wages would be negligible. . . 

Argument. This proposition is not so evident as the preced- 
ing; nor can it be accepted without larger qualifications and 
limitations. But it is still substantially true. If the whole 
producing group creates a demand for labor by producing, it 
follows that the labor part of the producing group creates a de- 
mand for labor by its producing. 

Doubtless it must be admitted that not all the demand created 
by labor's production will eventuate in a demand for other labor; 
since labor's demand for goods will be a demand for all the 
factors necessary to produce those goods, viz., land services 
and capital services, as well as labor services. But with the 
great majority of commodities, the contribution of labor, direct 
or indirect is by all odds the most important element; so that 
a demand for one dollar's worth of product is a demand for 
almost that much labor, counting, of course, all the labor which 
from first to last contributes to the result.* 

2. Employment as Dependent on the Supply of Land and 
Capital. 

In carrying forward the argument of the preceding discussion, 
it was assumed that, in demanding goods, the public create an 
equal demand for labor, and, so, create an equal amount of em- 
ployment. But we hardly need say that this presents only a 
partial view of the matter, since production requires other 
factors besides labor, viz., land and capital. A demand for 
goods can not constitute a demand for the labor needed to pro- 



'^I am not at all sure that this is not overstated." But I think it is not. 

285 



PRINCIPLES OF ECONOMICS 

duce those goods, unless there are land and capital available to 
complete the combination."5" 

The preceding comments have brought out the point that 
opportunities for employment are dependent on land and capital 
as being co-ordinate requisites of production, the presence of 
which is, therefore, necessary if there is to be a demand for 
labor. There is another reason for affirming the special depend- 
ence of labor for employment on capital. Besides supplying the 
produced materials and instruments of production, capital com- 
monly plays to a greater or less degree another role, viz., 
advancing the wages of current labor. Doubtless it is true 
that in some cases wages are not advanced at all. But in the 
majority of cases, they are advanced in the sense that a large 
part of the wages paid by the entrepreneurs during any particu- 
lar week or month are paid for labor which is devoted to produc- 
ing incomplete goods, — goods which will give money returns 
only at a later period. Because of this fact production involves 
a waiting additional to that involved in supplying the materials 
and instruments necessary. In short production requires some- 
where in the community a fund of circulating capital, neces- 
sary to supply the current wants of producers. As a very large 
part of its duty will be to make advances to laborers,- it may 
well be called the wage fund. 

Note. Without much question the classical economists for a 
time pushed too far the doctrine that employment and wages 
are dependent on capital, developing a special theory of wages, 
known as the wage-fund theory. According to this doctrine 
in its cruder form, there is at any moment .a fairly determinate 
sum of capital devoted to the purchase of labor services-, so that, 
unless the number of workmen changes, no change in the average 
of wages can be made, — an increase to one class being offset 
by a corresponding decrease to some other. In practical appli- 
cation, this theory was made to prov^ th^ futility of, strikes and 
most other methods of raising wages. So stated and so used, 
the doctrine probably did not deserve much consideration. Stjll 
it is a mistake to deny the fundamental truth involved in the 
doctrine. Employment is more or less dependent on a special 
section of capital, reasonably enough called the wage-fund. Other 

■^It is, of course, equally true that a demand for goods does not con- 
stitute a demand for the land necessary to produce those goods, unless 
there are available labor and capital to complete the combination. So a 
similar affirmation may be made with respect to capital. In short, in a 
sense each kind of productive goods constitutes a demand for the others. 
(Fetter, p. 218.) 

286 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

things being equal, workmen will fare better in the community 
which has the ampler stock of circulating capital available for 
the advancing of wages. 

As a rough summary of the preceding discussion, we may 
lay down the following: 

Principle. Broadly speaking, opportunities for employment, 
anyhow satisfactory opportunities, vary with the abundance of 
natural resources and capital. 

3. The Limits of Possible Employment. 

In the preceding discussion we brought out the reciprocal 
dependence of land, capital, and labor for opportunity. Rigidly 
interpreted, this doctrine would suggest that there is a certain 

definite limit to the opportunities of each of these factors, 

or, for our special purpose, to those going to labor, i.e., to em- 
ployment. Given a certain outfit of natural resources and capital, 
there will be opportunity to utilize a certain amount of labor and 
no more. Such an interpretation would nicely support - the 
popular notion that there are just so many jobs, no more ,and 
no less, so that giving one of them to one person necessarily 
takes one from some body else and vice versa. To the trained 
economist, this way of looking at the matter seems quite un- 
warranted. But possibly our present discussion may serve to- 
give it some color of sense. Does not the affirmation that land 
and capital, as well as labor, ^ are essential to production support 
the contention that labor opportunities are strictly limited? In 
answering this, we have to remind ourselves that all industry 
is, during some period anyhow, in the condition of Returns 
Increasable at Diminishing Rate. That is, even if the available 
quantities of land and capital are constant, 3^et increasing the 
amount of labor will increase the total return to the combination 
though not proportionately. Since the increase in return is the 
contribution in the product which will be credited to the addi- 
tional labor, and as such contribution will determine the price 
of labor, it follows that the new conditions will lower wages, 
still this will not alter the fact that the new labor has found^ 
employment. Accordingly, as a summary of the situation, we 
seem called on to say that, under ordinary conditions no one 
n£ed lack employment if he is content to accept that wage 
.^hich. expresses the new marginal productivity of labor. 
, The point made in the preceding paragraph — that opporfuni- 

287 



PRINCIPLES OF ECONOMICS 

ties for employment can be indefinitely increased — was perhaps 
sufficiently qualified to make it substantially true. Still the 
qualification needs development. As a basis for the argument, 
it ..was said that, during some period anyhozv, industry is in the 
condition of returns increasable at diminishing rate. Now, it 
is quite as certainly possible, that industry should reach a stage 
where its returns are substantially fixed, where they have 
reached their maximum; — even if the efforts of another laborer 
could increase the output somewhat, still the additional amount 
would be so small that even with the extremest conceivable 
economy it would not furnish subsistence. That is, employment 
is so far dependent on land and capital, and the possibilities of 
industry are so limited that a time is always liable to come when 
opportunities for employment can not experience any measurable 
increase, — no more laborers can be utilized. 

We have just seen that an absolute limit to employment may 
be reached by adding labor till the combination is brought to 
the point of substantially maximum returns. Doubtless in actual 
life the practical, effective limit is reached considerably earlier 
than this. The decline in the marginal productivity of labor does 
not go on till men could live on no less. Rather it stops where 
they' will live on no less. In earlier times conquering migration 
cut the Gordian knot. In our day peaceful emigration commonly 
proves sufficient, though occasionally force in the shape of 
colonial wars comes to the front.* 

.4., Employment as Affected by the Riva'ry of Capital. 
Roundabout methods are generally labor-saving methods, 
hence methods which in themselves decrease the need for labor 
as compared with the need for capital. Capital therefore appears 
as. in some sense the rival or competitor of labor. This fact 
has .naturally given rise to much controversy as to whether the 
introduction of improved methods does not diminish the total 
demand for labor. (1) All are agreed that immediately certain 
classes of laborers suffer by being thrown out of employment 
and compelled to make new adjustments. (2) Experience com- 
monly shows that, in any given industry taken as a whole, there 



*Further, in our day relief has repeatedly come from great improvements 
in method which have pushed far into the distance the point of maximum 
returns. 
' ' •' 288 



CHAPTER XIL SYSTEM OF DISTRIBUTION. 

is little, if any, decrease in employment ; because the lowered 
price due to lowered cost so stimulates demand that the old 
workers are needed to meet that demand even under the new 
and more efficient methods. (3) The lowered price due to 
lowered cost, if it does not create new demand, anyhow releases 
buying power saved because of the lower price, which will be 
spent on new products, save on the almost inconceivable hypoth- 
esis that goods have become so abundant and their marginal 
utility so low that people no longer want more things. But 
supplying these new products will furnish employment oppor- 
tunities for the labor displaced in the old industries. 

Note. These last considerations would not show that the in- 
troduction of improvements has no tendency to lower wages by 
making labor relatively rhore abundant and so lowering its 
marginal utility. We are here concerned only with opportunities 
for employment at some wage or other. 

5. Employment and Foreign Trade. 

One of the most obstinate of popular fallacies is the notion 
that the employment opportunities of the people of a particular 
community are diminished by carrying on trade with other com- 
munities. Buying outside takes away jobs from one's own 
people. Against this notion economists have always protested. 

Principle. Broadly speaking, changes in the extent to which 
goods are bought abroad have no effect on the amount of em- 
ployment. 

Caution. Remember that in this, as in any principle of 
science, , all conditions other than the one under consideration 
are assumed to be unchanged. For example, we must not sup- 
pose that, when we stop buying certain things abroad, there is 
an inflow of capital from abroad. Such a procedure would be 
introducing a change in conditions other than a mere decline of 
foreign buying. 

Argument. The principle laid down is quite obviously a 
mere corollary from the Principle of Reciprocity discussed in 
Chapter VII. Foreign trade is necessarily reciprocal. If we 
are buying abroad, we must be selling abroad, — must be deliver- 
ing the foreigner some form of wealth, anyhow money. But, in 
producing the commodity or commodities with which we pay 
the foreigner for our purchases, we obviously create opportuni- 
ties for employment just as truly as we should by producing 
the imported goods at home. There are some valid, if not 

289 



PRINCIPLES OF ECONOMICS 

weighty, arguments for artificially developing certain industries 
within our own borders; but this "more employment" argument 
is not one of them. 

Illustrative Problems. 

1. From Marryatt's Midshipman Easy: 

"Yes, my dear, this is all very well in the abstract, but how 
does it work?" 

"It works well. The luxury, the pampered state, the idleness, 
— if you please, the wickedness of the rich, all contribute to the 
support, the comfort, and the employment of the poor. You 
may behold extravagance, — it is a vice; but that very extrava- 
gance circulates money, and the vice of one contributes to the 
happiness of many." Criticise. 

2. In his Economics of Industry, p. 323, Marshall says that 
"the agents of production are the sole source of employment 
for one another" and that "an increase of capital enriches the 
field for the employment of labor." 

Discuss these statements. 

3. Most economists believe in what we called Say's Law; 
yet most of them also favor "making work" for the laboring 
classes during an industrial depression, i. e., spending money for 
enterprises which would not for their own sakes have been 
undertaken at this time. 

(a) Show that a resort to this expedient seems at first 
sight inconsistent with Say's Law. 

(b) Defend a resort to this expedient in exceptional cases. 

4. "It is a pretty well established principle that the extent 
of the demand for commodities determines business prosperity. 
It is equally clear that this demand is governed by the consump- 
tion of wealth by the masses, and that this consumption is 
determined by the general standard of living in the community. 
Therefore whatever tends to develop that standard of living 
tends to promote the sale of commodities and thus to increase 
production. Therefore it is necessary to raise the standard of 
wages to increase production." (R. B. Cunninghame Graham.) 
Criticise carefully. 

5. A millionaire of Los Angeles recently donated $300,000 to 
maintain a certain propaganda. The Detroit News in an edi- 
torial comments on the fact as follows: "There is little excuse 
for appropriating money with which to put human intelligence 
and the freedom of the will in bondage. However, $300,000 
v^^ill furnish employment to a certain number of human beings 
anyway. The money will flow out through the channels of trade 
and be very helpful to the commercial world, and that is some- 
thing to be thankful for." 

290 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

(a) Will this expenditure increase the total amount of em- 
ployment? Explain. 

(b) Is it probable that the channels of trade will have any 
more money flowing in them? Explain. 

6. '"It seems certain that, for the existing population any- 
how, the final effect of all successful efforts to establish a wage 
minimum, whether by public or private action, must be to increase 
the number of the permanently unemployed." 

Argue for the truth of this statement. 

7. "Admitting the truth of the statement in Problem 6, I 
still believe that wages will in the long run be raised as a result 
of the various efforts which are being made to fix a minimum 
below which wages are not to be allowed to fall." 

Argue for the soundness of this opinion. 

8. "In the long run the entrance of women and children into 
the field of labor does not drive out an equal amount of male 
labor. Their products add as much to the demand for labor 
as their labor adds to the supply of labor. Consequently no one 
should object to the employment of women and children." 

Is this argument conclusive against laws restricting the em- 
ployment in question? 

9. "If there were two communities on the same industrial 
level, each with an aggregate income of $10,000,000,000, but one 
of these distributed this income so that the wage earners took 
only $3,000,000,000, while in the other they took $5,000,000,000, 
surely no one will contend that the volume of general demand 
would not be larger in the latter." Criticise. 

Section G. Special Consideration of Interest. 

As the student is doubtless aware, it is the incomes derived 
from property, rather than those derived from labor, which have 
given rise to serious controversies, whether in respect to their 
origin, their determination, or their legitimacy. These incomes, 
we remember, are rent, interest, and profits. Among these, rent 
presents comparatively few difficulties and has given rise to 
few great theoretic differences ; though, even in this case, perfect 
unanimity is lacking. But interest and profits always have been, 
and still are, subjects much in controversy. Of the two, interest 
presents the greatest difficulties and will be treated first. 

1. The Interest Phenomenon. 

Our first task must be to develop fairly clear and definite 
ideas of what the interest phenomenon is. The most familiar 
case is that of the ordinary money loan; i. e., a transaction in 
which the lender puts at the complete disposal of the borrower 

291 



PRINCIPLES OF ECONOMICS 

a sum of money, which money or an equivalent sum, is to be 
returned to the lender after a stated period, — and, in return for 
the advantages which are supposed to accrue to the borrower 
from this operation, said borrower makes to the lender a special 
payment amounting to a small per cent of the sum loaned and 
proportioned to the length of time for which the loan is to run. 
Said special payment is of course the interest we are talking 
about. 

The type of interest involved in the case given above is 
commonly called contractual, or, sometimes, explicit interest. 
It is open, avowed interest. But there are besides many cases 
in which interest is just as truly present, but in which it is more 
or less concealed, disguised, — implicit interest. Thus, merchants- 
frequently charge higher prices for the same goods to credit 
customers than to those who pay cash.* Here the difference 
in price may be characterized as amounting to interest, — as being 
in effect interest. The merchant, in having to wait for his pay, 
in effect lends to the buyer a sum of money equal to the value 
of the goods. If he openly charged interest on the account, 
we should have a case of explicit interest. But he considers 
it better policy to conceal the fact and so merely charges a 
higher price for the goads. 

A rather more significant case of implicit interest is:, to, be 
found in the relation between the prices of ordinary producible 
goods and their costs in other goods, current labor, and risk- 
taking. Each unit of product has to have a price high enough 
*o cover, not only the items just enumerated, but also interest 
fin the invested capital, i. e., on the sum of money which the 
entrepreneur could get from the sale of his whole outfit. This 
must be so, the business man would say, because otherwise no 
one would devote his money to manufacturing commodities ; 
instead every one would lend it, getting contractual or explicit 
interest. This is inadequate if it is meant to be a complete 
explanation of interest ; since sums of money are, so to speak, 
merely formal capital, and the deeper explanation must be found 
in the relations to each other of those things which borrowed 
money is used to buy rather than in money relations as such. 

But, after all, treating the fact that money-loan interest exists 

« ' 

. *It is assumed that this addition to urice is not made in order to cover 
risk. 

292 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

as a reason wh}^ implicit interest must exist is not substantially- 
wrong; since it is in the market for money-loans that the various 
forces which are causing interest to exist and determining "its 
rate, most completely manifest themselves. Accordingly, the 
business man's method of arguing at this point supplies a clue 
which will tell us where to look for implicit interest. That is, 
wherever we find a person occupying an economic relation such 
that because of that relation he is depriving himself of an 
opportunity to make money loans and receive interest therefor, 
we may be sure that we have a case of implicit interest. Such a 
situation we shall always have when the person in question 
owns property which gives off its services only piecemeal, which, 
therefore, must be owned during some measurable period of 
time. In short, every case of durable goods involves the interest 
phenomenon. 

Illustrative Problems. 

1. Show just how the interest phenomenon is involved in 
the non-producible income-bearers discussed in Section E, Chap- 
ter IX. 

2. Do the same for producible income-bearers, say, gasoline 
launches rented by the day or week at someT summer resort. 
Compare the two cases. 

3. Try to make an argument to prove that even in the case 
of a durable good which is not an income-bearer in the ordinary 
sense, being devoted to yielding its owner an income of services 
used directly to give himself satisfactions, we must believe that 
interest is in a very real sense involved. (Take the example 
of a $1,200 automobile destined for the buyer's own use, 
expected to last only four years, and ask yourself how much 
valuation he must set on an annual use of the machine to make 
his purchase reasonable.) 

2. Essential Nature of the Interest Phenomenon. 

The surface marks of the interest phenomenon offer no great 
difficulty and have probably been brought out w-ith sufficient 
distinctness in the preceding discussion. When, however, we 
inquire as to the real inner nature of interest, w^e have a very 
different story. From the earliest time there have been serious 
controversies with respect to the rightfulness of interest-taking; 
and these controversies have continued unsettled down to our 
own day. Now, this perennial character of the controversy 
is largely due to the difficulties experienced in trying to ascertain 
the real nature and origin of interest. 

293 



PRINCIPLES OF ECONOMICS 

Of the various attempts to characterize with precision the 
real nature of interest, two have been most in vogue and perhaps 
may be said to include most of the others: the use theory and 
the exchange theor}^ The former way of conceiving the matter 
is almost universal in the business world and has been widely 
held by economists, though in recent years it has largely given 
place to the exchange theory. According to the use doctrine, 
interest is a payment for the use of capital conceived as a sum 
of money or money value embodied in any capital good. If a 
manufacturer borrows at the bank on his ninety-day note $600 
to buy 200 tons of coal wherewith to run his engines, he obvi- 
ously gets all the uses of the coal but in addition he may be 
said to get a ninety-days use of the $600 embodied in the coal. 
Similarly, if Mr. Elder buys a $1200 automobile on a one-year 
note, he gets all the services which any cash buyer could get 
out of the machine and in addition is thought of as getting 
the use of $1200 for a year's time. 

In explaining the nature of the exchange theory, our best 
procedure perhaps is to begin by pointing out the fault in the 
use doctrine. No one denies, of course, that the borrower or 
the credit buyer gets some advantage, service, utility, in addition 
to the services of the coal or the automobile ; — if he did not, 
he surely would not pay the interest. But those who reject 
the use theory affirm that that theory errs in its method of 
characterizing or classifying said advantage or service. The 
advantage of the man who buys goods with borrowed money 
or on credit consists, not in receiving a greater sum of utilities 
than the men who buy similar goods with their own money or 
for cash, but in that he pays what is to him a smaller price. 
He is given all the prerogatives which belong to an owner who 
has purchased the goods, although he has not made the comple- 
mentary sacrifice involved in buying them, — has not in the 
deepest sense bought them at all. In short his additional advan- 
tage over the non-credit buyer consists in postponing the sacrifice 
necessary to becoming the rightful owner of the utilities of the 
goods. 

The exchange theory as to the nature of interest is now 
readily comprehended. According to that theory, interest is in 
reality a bonus, a premium, a something to boot which the man 

294 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

who buys goods now but does not himself pay for them ;till 
some future time, gives to the person who enables him to effect 
this transaction. Or, looking at the matter from the lender's 
end, as better fits some cases, interest is a bonus or premium 
which the man who relinquishes his right to goods now but 
gets his pay only at a later date, receives for making this 
exchange. To put the theory in more conventional form : When- 
ever present goods are exchanged for future goods, a bonus or 
premium is paid by the party who brings to the exchange future 
goods, to the party who brings present goods, because future 
goods are worth less, unit for unit, than present goods; and 
this bonus or premium constitutes interest. 

Note. While I am disposed to agree with the advocate^s of 
the exchange theory, I find it difficult to avoid altogether such 
expressions as this : "Interest is paid for the use of capital, or 
the services of capital" ; and I do not believe that this usage 
is productive of any serious harm. 

3. Are Capital-services Productive? 

In discussing the Productivity Principle in the earlier part of 
this chapter, it was assumed that that principle applies to the 
services of capital as well as to those of land and labor. But, 
obviously, this is legitimate only on condition that capital ser- 
vices are productive in some serious meaning of the term. 
But this is an assumption which would seem to many persons 
quite unwarranted. Indeed, it would seem that any one who 
gives his adhesion to the Exchange theory just explained is 
thereby estopped from claiming that capital is productive. Is it 
not in the very essence of that theory to deny, productivity 
in that it declares that the credit buyer docs not get any more 
utilities than the cash buyer, but merely postpones payment for 
those he does get? Now, I am not disposed to deny that there 
are definitions of the word produce eminently convenient if not 
quite indispensable, which are too narrow to include the offices 
of capital. I might even be willing to concede that the definition 
suitable for the majority of purposes is in this class. But we 
must still insist that, in a deeper and very important sense, 
capital is truly productive, — the capitalist is a producer. Pro- 
duction, in its fullest sense, must include every act which is 
consciously performed in response to economic motives and 
which results in some economic advantage, i. e., an advantage 

295 



PRINCIPLES OF ECONOMICS 

far which men are willing to pay a price. Any narrower 
definition than this is entirely unsuited for dealing with the 
problems of distribution which inevitably bring to the front 
questions of right and wrong, claims or rights produced by 
actions, and which, in doing this, compel us to locate responsi- 
bility, — to determine to whom and to what, any particular advan- 
tage is properly to be credited. Again this definition is alone 
adequate in that it brings out the only result which can properly 
claim to be the true end of all economic production — i. e., 
advantage. Time was when production must result in added raw 
materials. Later thinkers became liberal enough to be satisfied 
if it only manufactured those materials. Still later the mere 
transporting of things was recognized as productive. And so on. 
Now, all this shows that the truly correct procedure is to 
admit that the only necessary mark of production as respects 
the result, is that it brings into existence advantages. Judged 
by such a conception of production, the role of the capitalist is 
surely a productive one. 

In the preceding discussion we have argued for the produc- 
tivity of capital broadly, in a general way. The great importance 
of the question seems to demand a little more specific considera- 
tion of the really significant case, i. e., the case of capital which 
is being employed productively in the popular meaning of the 
term, e. g., the raw materials, engines, machinery, etc., of a chair 
factory. Is it proper to impute any portion of the product of 
such a factory to the capital invested, as capital, i. e., as some- 
thing different from the labor necessary to produce that capital? 
Thus, to use a highly artificial example, let us suppose that a 
certain chair factory turns out each month 70,000 chairs, of 
which number 20,000 become in effect the wages of current 
labor, 40,000 become in effect the wages of past labor embodied 
in the materials, engines, machines, etc., while 10,000 become 
the return to the capitalist, — it being assumed that the landlord 
and the entrepreneur as such get nothing; question: Are the 
10,000 chairs which go to the capitalist as such properly credited 
to said capitalist as in some sense his product, or, in strict 
scientific accuracy, must they be credited to the past labor in- 
volved as its product, even though for some other good reason 
they ought to become the share of the capitalist? I hardly need 
say, that, consistently with our previous contentions, we can not 

296 



CHAPTER XII. SYSTEM jOF DISTRIBUTION. 

avoid answering that they must be credited to the capitalist as 
his product. Our reasons for this conclusion are best brought 
out in a series of formal propositions. 

(1) Even if capitalistic production, as contrasted with non- 
capitalistic, must be conceived as involving merely a different 
method of utilizing labour, yet the employment of this mor^ 
efficient method involves conscious choice, — -it does not go as a 
matter of course. 

(2) The choice of the capitalistic method involves the ful- 
filment of a condition — having power to wait — ^which can be 
fulfilled by laborers only to a very small degree. 

(3) The supplying of this necessary condition can, how- 
ever, be undertaken by persons other than laborers, and so the 
supply of power to wait, and therefore the extent to which the 
more efficient capitalistic method can be employed, can be in- 
fluenced by persons other than laborers. In consequence, the 
power to enable producers to employ said methods becomes an 
ordinary economic good, a good distinguishable from other 
factors and having a price. 

(4) The volume of this additional factor in production — 
waiting power — is limited, and so limited that in many cases 
producers are obliged to forego the employment of methods 
ivhich zuould be more eMcient than those they do employ. 

(5) Under these conditions producers are bound to feel 
that, even in the least important case where it is used, the power 
to choose the more capitalistic method is really important to 
them, and feeling this they must credit to it some portion of the 
product; since otherwise they might easily make the mistake of 
using it for some less important purpose, — for producing some 
submarginal product. That is, capital as capital, — capital as 
waiting power in distinction frOm capital as the result of labor, — 
must be credited with a part of the joint product, — is, then, truly 
productive. 

Illustrative Problems. 

: 1. "That capitalis productive has often been questioned, but 
no one would deny that tools and other materials of production 
are useful ; yet these two propositions mean exactly the same 
when correctly understood." 

Show that those persons who object to calling capital pro- 
ductive would hardly be- satisfied with the. above proof. (For 

297 



PRINCIPLES OF ECONOMICS 

the use which the author quoted made of the productivity of 
capital, his conception of productivity is all right enough ; but 
it is not the conception of those whom he affects to answer.) 

2. Suppose that a fisherman could catch 21 fish a day with- 
out the aid of a net or boat or any other form of capital ; that 
to make a net would cost him thirty days' labor; and that it 
would last only thirty days. 

(a) What is the smallest number of fish which the net 
must enable him to catch each day in order to justify our 
saying in this case that capital as capital is productive? 

(b) Supposing that the fisherman catches with the aid of 
the net 200 fish a day, what is the maximum productivity which 
could be credited to the capital as capital. 

(c) Under what circumstances would that maximum tend 
to be so credited to capital? 

(d) Supposing that only 1000 fish were actually credited to 
the net as its product, hov/ would you explain the fact? 

(e) Can you imagine a condition of things under which no 
part of the catch would be credited to the net? 

3. In order that we should impute productivity to capital, is 
it necessary that some part of the capital supplied should have 
cost abstinence or waiting? 

4. It is usual to say that even goods ready for consumption, 
e.g., a loaf of bread, are capital so long as they are in the hands 
of the producers or dealers. 

(a) Try to show that such a way of looking at the matter 
is reasonable. 

(b) Is there any interest present in such a case? 

(c) Can such capital properly be described as productive? 

4. Does the Return to Capital Submit Itself to the Pro- 
ductivity or Service-Value Principle? 

Our affirmative answer to the previous question almost in- 
volves the same one here. Still it might be argued that the 
peculiar character of the element under consideration renders 
less likely our successful isolation of its share in the joint 
product, even if one admits that it has such a share. An engine 
is capital, or anyhow capital goods ; but we do not mean by the 
contribution of the engine all its contribution. The larger part 
of that contribution is to be credited to the labor spent in pro- 
ducing the engine. Here we are concerned only with the part 
of the whole contribution imputable to the waiting power em- 
bodied in the engine. To expect entrepreneurs to isolate this 
would seem to be attributing to them quite exceptional powers 
of analysis as well as exceptional capacity to trace the working 

298 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

of intermingled forces. But all this is a bogey which need not 
frighten any one. (a) As already fully explained in Section G, 
Chapter IX, the process whereby each factor in production is 
assured a price expressing its marginal contribution is an 
automatic process involving comparatively little insight on the 
part of entrepreneurs, (b) But, in reality, the case of waiting 
power offers in actual practice no greater difficulties than other 
factors. To the entrepreneur, waiting power presents itself as a 
thing which he buys in isolation on the open market; i.e., as 
the right to use some other man's money. When he is consider- 
ing whether or not it will pay him to make his methods more 
capitalistic — to use a larger proportion of congealed labor, a 
smaller one of current labor — the answer turns on one very 
simple matter, the rate of interest. It is, of course, true that, if 
an entrepreneur puts $10,000 worth of labor into the improving 
of his plant, this procedure must cost him, not only the $500 in- 
terest on the money, but also the $10,000 expended for the labor, 
and, so, surely the returns from the business must be adequate 
to cover the $10,000 as well as the $500. But, then, this is no 
concern of the interest problem. That problem has to do only 
with the choice between two methods of utilizing the $10,000 
worth of labor; the direct and the roundabout. The cost of 
the labor is in either case $10,000; but the cost of the power to 
choose the roundabout instead of the direct method is only $500. 
In the actual world, accordingly, the task of ascertaining 
whether waiting power is worth to the entrepreneur what it 
costs him offers no greater difficulties than the same task 
in the case of labor. We conclude, then, that the reasoning 
which was employed in Section G, Chapter IX, to show that the 
market automatically isolates the marginal contribution of each 
factor and assures to that factor a corresponding price, finds no 
peculiar difficulties in dealing with the case of capital and 
interest. 

5. Does the Return to Capital Submit Itself to the Disutility 
Principle ? 

That there is a disutility or sacrifice involved in supplying 
capital has already been argued more than once, and would 
seem to need little more comment. It may be that we shall 
have to relinquish altogether the earlier doctrine that in absti- 
nence we have a cost cooramate with labor, and accept instead 

299 



PRINCIPLES OF ECONOMICS 

the contention of Boehm that the capitalist's sacrifice consists, 
not in an increased cost, but rather in a diminished reward for 
incurring the original cost. But even so, we have an added 
sacrifice the making of which is necessary if we would pursue 
capitalistic methods. The supplying of capital, therefore, in^ 
volves a disutility or sacrifice. 

The question still remains, however, as to whether there is 
any such connection between the disutility cost of capital and 
the market price of its use — the rate of interest — that said price 
must express the marginal disutility involved in supplying the 
capital. Doubtless we must admit that a negative answer is 
possible. The volume of accumulation is unquestionably influ- 
enced by other conditions than the rate of interest. For ex- 
ample, some persons are in a position to spare from the present 
without appreciable sacrifice while, at the same time, they are 
anxious to provide a fund for the future. Such persons would 
accumulate capital even if they were obliged to pay for the 
privilege of doing so. It is, therefore, conceivable that the 
amount of capital actually supplied to the market is not in- 
fluenced in any substantial degree by a regard to the interest 
paid. If not strictly a fixed-output good, it would be one, the 
output of which would have its fluctuations determined only 
through the power of forces other than cost. The price of its 
use, therefore, would not have to conform in any degree to the 
sacrifice involved. 

But, while such a state of things as that just described is 
conceivable, its actual existence seems in the highest degree 
improbable. There is one type of accumulation, certainly, which 
is motived by considerations of direct economic gain. I mean 
the getting together a small sum to make a start in business 
or speculation. Doubtless we are not here dealing with pure in- 
terest — the profit expected is the more important item. Still the 
case must of course involve the interest problem ; since the entre- 
preneur who puts his own capital into the business can not help 
performing the zvaiting function of the capitalist as well as the 
responsibility-taking function. Now, it can hardly be doubted 
that every year a large amount of capital comes into existence 
in this way; and it is hard to believe that it plays no part in 
determining the rate of interest. But, finally, it seems impos- 
sible to believe that the accumulating of that portion of capital 

300 



CHAPTER XIi: SYSTEM OF DISTRIBUTION. 

which is devoted to earning interest only is not materially influ- 
enced by the immediate reward in the shape of interest. Surely 
there must be not a few people in such a position that they 
naturally say : The rate of interest has fallen so low that it 
really is not worth my while to save any more ; I would better 
enjoy the present. If so, their decision for or against further 
saving must surely change the volume of capital sufficiently to 
modify its price. Putting the matter in a still different way, 
can it be seriously doubted that a fail in the rate of interest to 
zero would diminish the stream of new capital, or that a rise 
to ten per cent would increase that stream? If not, then we 
must say that the price of the use of capital must tend to ex- 
press the marginal disutility of supplying it. 

. Illustrative Peoblems. 

1. 'Tt is absurd to call a course of action which is deliberately 
chosen as preferable to its opposite, a sacrifice. ■ When the 
capitalist gives up a present good in order to gain a future one, 
by that very action he shows that he is not making a sacrifice, 
i.e., he shows that he prefers the future good to the present one." 
Prove by similar reasoning that labor is not a sacrifice cost. 

2. "The old-fashioned notion that capital is built out of sav- 
ings has little or no application under our regime of corporate 
organization. What happens nowadays is that the corporation 
.simply puts some portion of its huge earnings into improvemejits 
such as buildings, machinery, side-tracks, etc. ; so that saving 
is no longer required." 

(a) Show that the modern method as expressed in the second 
sentence involves no essential change in procedure. 

(b) Show that this modern procedure may involve, probably 
does involve, not a few cases of really onerous saving. 

6. The Rate of Interest and the Quantity of Money. 

A very persistent and troublesome popular fallacy makes the 
rate of interest to vary inversely as the quantity of money. 
This fallacy seems to spring from a confusing of money and 
capital. Such a confusing is not, perhaps, so very unnatural in 
view of the fact that the hnmediate form in which the use of 
capital is marketed is a fund of money or its equivalent, bank 
credit. In fact so fully is this true that, in the long run and 
supposing no tinkering with the money stock, we may quite 
safely take as our guide to the interest relations prevailing 
among the real capital goods, the market for mere money 

301 



PRINCIPLES OF ECONOMICS 

capital. But this is only because in the long run those interest 
relations prevailing among the real capital goods find full ex- 
pression in the market for money capital. It is surely in the 
demand for and the supply of engines, machines, lumber, etc., 
rather than in the demand for and the supply of mere money 
that we should look for the more ultimate causes determinative 
of interest. 

Principle. In the long run, the rate of interest must he de- 
termined in substantial independence of the quantity of money. 

Argument, A. In General. What the borrower really 
wants is not money but goods, — engines, cars, rails, labor, etc. 
It is surely foolish to expect that putting out more coin or more 
paper money will make the real things, engines, cars, etc, 
cheaper to borrowers, or, vice versa, that withdrawing money 
will make those things dearer, 

B. More Specifically. If we suppose the rate of interest to 
-be lowered at first by the increase of money, the natural working 
of things will soon reverse the movement, (1) The lower rate 
will lead to extensive borrowing and buying of goods, (2) This 
will raise the prices of goods; since they have not increased 
though the money has. (3) This will compel borrowers to bor- 
row more money in order to get the same amount of goods. 
(4) This will raise the rate of interest back to its old place,* 

But, while in the long run we can not expect to influence 
materially the rate of interest (discount) by altering the quan- 
tity of money in circulation, we can for brief periods accomplish 
the. result named. In fact governments and powerful banks 
at times consider it one of their functions to manipulate the 
money stock for the express purpose of raising or lowering 
the rate of discount. Thus, the Bank of England has in several 
instances contracted the circulation of London in order to force 
on the market a higher rate. Now, the possibility of bringing 
about such results in the way indicated rests upon the following 

Principle. For short periods {a few weeks or months), the 
rate of discount {interest) tends to equal that rate which ex- 
presses the marginal utility of the stock of money capital without 



*In fact, it is generally held that, when the stock of money is increasing, 
.the expected fall in its value — rise in prices— will cause lenders to hold back 
for a higher rate of interest in order to insure themselves against loss on 
■the principal. Argued fully in Fisher's Appreciation and Interest. 

302 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

much regard to the marginal utility of goods capital or the dis- 
utility of saving. 

Argument A. The short-time rate adjusts itself to the 
marginal utility of money capital without much regard to goods 
capital, because short-time loans largely connect themselves with 
the need for money, not to invest productively, but to meet money 
obligations. Here the demand is emphatically for money itself, 
not something which money will buy. 

B. The short-time rate adjusts itself to the marginal utility 
of money capital with little regard to the disutility of saving. 
This is simply the old case of short-time normals being deter- 
mined without respect to cost of production. During a series 
of years, the price of wheat tends to equal its marginal cost 
of production. But, between two harvests, its price tends to 
be one which expresses the marginal utility of the existing 
stock. 

Illustrative Problems. 

1. The law of 1900 for the better protection of the gold 
standard provided among other things that under certain cir- 
cumstances treasury notes (greenbacks) which have been re- 
deemed shall not be paid out even in exchange for gold, but 
shall be hoarded, thus contracting the total currency. This was 
doubtless intended to protect the Treasury when a heavy gold 
export was in progress ; and, whether intended or not, it will 
doubtless tend to check such a gold export. Argue for the cor- 
rectness of the statement after the semi-colon. 

2. At present the Imperial Bank of Germany has the un- 
conditional right to issue only 450 millions of uncovered (not 
backed by an equal amount of gold) notes; but, by paying a tax 
of 5 per cent on any excess over said amount, it may expand 
the issue indefinitely. It is believed that this power can be used, 
and is used, to keep the rate of discount much more uniform 
than it would naturally be. Show that we can reasonably look 
for such a result. 

7. The Rate of Interest and Risk. 

It is a familiar fact that at any one time the current rate 
of interest on capital used for the same general purpose differs 
greatly in different places, say Ann Arbor and Spokane, and that 
even in the same place at the same time it perhaps differs 
widely when the capital involved is put to different uses. The 
chief explanation of these differences is doubtless inequality 
in the matter of risk. The excess over, say, four per cent in a 

303 



PRINCIPLES OF ECONOMICS 

given time and place may be conceived as an insurance premium, 
a contribution to the fund necessary to cover loses from bad 
debtors, or perhaps as a payment nesessary to overcome the 
natural indisposition of the lender to take chances. If we 
understand by "gross interest" the amount actually paid and 
by "pure interest" the rate paid to cover the simple use of capital 
or waiting power, we may lay down the following principle, 
which, though obvious and familiar, is of great importance and, 
unfortunately, is often overlooked. 

Principle. The amount by which gross interest in any par- 
ticular case exceeds pure interest tends to vary roughly as the 
risk involved. 

Illustrative Problem s. 

1. Show that usury laws would tend to raise the rate of 
interest 

2. Is'it reasonable to accept as true the statements of a bond 
agent who tells you that the bond which he has for sale is a 
gilt-edged one — i.e., that is absolutely secure — although it pays 
7 per cent interest? 

3. Give examples of some kinds of laws which you think 
would naturally cause the rate of interest to rise in a given state 
our country. 

4. How do you explain the fact that the rate of interest on 
ordinary loans will often be 6 or 7 per cent in Detroit, while. 
at the same time, it is only 4 or 5 per cent in New York City; 
although an impartial observer would hold that there is really 
no greater absolute risk in the one case than in the other? 

Section H. Special Consideration of Profits. 

1. The Nature of Profits. 

Profits, as the term is frequently used by the general public, 
include the whole net return to the responsible owner of a busi- 
ness, i.e., the whole return after money outlay has been deducted 
from money receipts. This whole return, which we might call 
Gross Profits, usually includes at least three elements, (1) 
wages of some sort, principally for management, (2) interest 
on capital invested, and (3) a remuneration for taking the 
responsibility of production, and making certain final decisions 
which necessarily fall to the owner. The first element has come 
to be eliminated from profits even in the popular sense of the 
term because of the great extension of the corporate form of 
business in which the work of management is turned over to 

304 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

hired officials. The second element, interest, is still commonly 
included. That is, stockholders in a concern paying seven per 
cent dividends would com.monly think of the business as yielding 
seven per cent profit, rather than four per cent interest plus 
three per cent profit. In this sense, profit is contrasted with 
interest in being the return to the capitalist who bears the whole 
burden of ownership, waiting plus responsibility-taking; while 
interest is the return to the capitalist who assumes only one 
part of the burden, waiting. In economics, however, we often 
find it convenient to limit profits to the third element, the taking 
of responsibility and making final decisions. From this point 
of view, profits in the case above would be only three per 
cent, i.e., the difference between what the capital would have 
received if lent to the company and what it actually did receive 
as invested in the business. Profit, in this sense, we will call 
Pure Profits or Profits Proper. 

(1) Pure Profits involve an infinitestimal element of wages, 
in that the owner must make certain final decisions. But in 
practice this tends to become negligible. (2) Pure profits, as 
the return for responsibility-taking, involves something more 
than a remuneration for assuming economic risk ; for assuming 
economic risk is not the only disutility or sacrifice connected 
with the taking of responsibility. But no doubt risk bearing 
is the chief element in the case. 

That risk for the bearing of which profits are paid must 
not be confused with the regularly recurring — calculable — losses 
of a business. Such losses simply increase the outlay for labor 
and capital goods. The remuneration received by the entre- 
preneur because of such losses would never be thought of as 
profits, but only as replacing of costs. The risk for which profits 
are paid is the risk of losses which cannot be recouped in the 
experience of the individual entrepreneur, — risks of total failure, 
or some loss almost as great. Compare the breakage of bottles 
in the brewery business with the chance that temperance legis- 
lation will destroy the business. The former is covered by 
greater outlay. The latter is a not-to-be-compensated loss. It 
cannot be met by any fund, unless brewers co-operate to insure 
one another, i.e., unless competition is replaced by consolidation. 
Here we have a true risk, — a case where there is real danger 
of real loss. To induce men to assume such, a risk, they must 

305 



PRINCIPLES OF ECONOMICS 

be paid something, not of course enough to cover the loss if 
the risk should become a certainty, but enough to move their 
wills, to induce them to assume the risk. It is thus evident that 
profits must not be conceived as a contribution to an insurance 
fund from which losses are covered. There is no such fund; 
the losses are not covered. 

Under Socialism, the sort of risk now remunerated by profits 
would in the main be covered by an insurance fund ; since the 
state, having a complete monopoly of production, would pool 
in its own hands all risks, and, as well, all chances of occasional 
gain. The risk cost of production, therefore, would become 
simply more capital and labor cost, instead of being, as now, 
the price of the psychological disutility of undertaking risks. 
(Perhaps the latter element would not be wholly eliminated in 
the case of long time enterprises undertaken for future genera- 
tions.) It is probable that under socialism the state would 
charge each commodity with the average cost of the whole out- 
put of that commodity, including successful and unsuccessful 
branches of the industry involved. Profits, as an element of cost, 
would not therefore be eliminated under socialism, but would 
appear in another guise. 

From the preceding analysis it results that, under the present 
order, profits may be much larger or much smaller than the 
insurance fund necessary to cover the real economic risk. It 
seems probable that, where risk is reduced to a minimum, profits 
■are larger than the necessary insurance fund ; but, where risk 
is very great, profits are much smaller than the necessary insur- 
ance fund. 

2. The Kinds of Profits. 

Profits, we hardly need say, offer much greater diversity 
than any other of the regular economic incomes. In fact one 
often questions the propriety of treating them under a com- 
mon head. Still they all have the common mark of being re- 
ceived by the person or persons who take final responsibility, 
and they all, in greater or less degree, connect themselves with 
the most conspicuous element in responsibility-bearing, i.e., 
risk-taking. Their differences, however, are so great that we 
are almost obliged to distinguish them in any full treatment of 
the. conditions by which they are determined. We here distin- 
guish four chief sorts. 

306 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

(a) Ordinary Fvofits. By these we mean the profits realized 
in well-established lines of business wherein no considerable 
amount of risk is involved. Ordinary profits, again, may be 
subdivided into Necessary and Differential. By the former we 
mean profits which must be paid even to the marginal employer. 
By differential profits we mean profits received by entrepreneurs 
of grades superior to the marginal one, in excess of the profits 
paid to the latter. 

Notes, (1) A number of prominent economists hold that 
profits tend to disappear in such industries as those here con- 
sidered, — said profits being eliminated by the competition of 
entrepreneurs. We will give some reasons for the contrary 
opinion a little later. 

(2) By the marginal entrepreneur we mean, not the least 
efficient one actually producing, but rather the least efficient one 
of those actually producing who under normal conditions will 
continue in the business and will he succeeded by others who 
voluntarily take his place. The purpose of this statement is to 
exclude from consideration a type of entrepreneur who must 
always be thought of as an anomaly from the study of whom 
no valid principle for normal conditions can be derived. The 
type in question is the man who, though failing to make profits, 
interest, or wages, though even losing little by little his very 
capital, keeps on in the business because he has no other choice. 
The facts with respect to such an entrepreneur are of no scien- 
tific significance in studying the principles of price or those 
which govern distribution. 

(3) It is somewhat doubtful whether we ought to recognize 
the kind of profits above designated differential; for these, being 
derived from the superior efficiency of one entrepreneur as 
compared with another, seem to be wages. This is quite correct 
as respects a large part of what is commonly thought of as 
differential profits. Still, it is probably our duty to retain the 
category. As already indicated above (page 305), we can fiever 
completely eliminate from the function of the entrepreneur the 
element of management; — he must share in the making of 
certain ultimate decisions. In consequence, there will tend to be 
a residuum of differential profits, even if we make quite universal 
the corporation practice of turning over the function of manage- 
ment to hired servants. 

(b) A second sort of profits is naturally designated Enter- 
prise Profits. These are the profits reaped by the initiators of 
industrial enterprises. They almost necessarily contain a monop- 
olistic element. In the case of patent rights, this is secured to 
the entrepreneur by the action of the public. Oftener the tincture 
of monopoly comes from the fact that the development of com- 

307 



PRINCIPLES OF ECONOMICS 

petition takes time, and, so, the pioneer in a given field has a 
quasi-monopoly for a brief period after success becomes as- 
sured. 

In the case of enterprise profits, it is more difficult than 
ordinarily to eliminate the element of wages. As a usual thing, 
some of the men who initiate an enterprise, for a time anyhow, 
perform labor services in connection with it, e.g., promoting 
financing, etc., and, in performing these functions, often do not 
work for defined salaries or commissions. Even if a defined 
commission is assured them, it is usually in the form of shares 
in the business, and, so, its real amount is conditioned upon the 
success or failure of the enterprise and, hence, is conditioned 
more or less fully on the efficiency or inefficiency of the receiver 
himself. 

(c) Speculative Profits scarcely need any definition beyond 
their name. They are seen when men consciously speculate, i.e., 
consciously deal in goods for the sole purpose of reaping the 
gains which may arise from changes in price. 

(d) Accidental Profits arise when some quite unforeseen, not- 
to-be-anticipated condition increases the income-producing power 
of a given property, e.g., the decision of some important semi- 
public institution to establish its quarters in a different part of a 
great city. This naturally increases the demand for neighboring 
sites at greatly increased rents. 

(e) Monopoly Profits are obviously profits received by the 
owners of any monopolistic business. 

3. Do Profits Submit to the Productivity or Service- Value 
Principle? 

It can not be denied that, of all the regular economic shares, 
profits are decidedly the most troublesome when we try to place 
them under the productivity principle when rigidly interpreted. 
Of course, there is no difficulty showing that the receivers of 
.profits as a class perform a service, — produce something. In 
some sense, anyhow, profits are correlated to a utility produced. 
Further, it seems almost equally certain that profits are in some 
rough way proportioned to the utility rendered. Thus, all must 
admit that those persons who initiate a commercially dubious, 
,bi4 socially important, enterprise perform a greater service 
than those who carry on the same in later years when 

308 



CHAPTER XII. SYSTEM OF DISTRIBUTION, 

success is assured. But, granting that in the case of profits there- 
is a rough correspondence between the reward and the service 
rendered, it does not seem possible to affirm even the degree of 
correspondence at this point which we believe exists in the case 
of wages and interest. Accordingly, some specific statements 
bearing on this special case of profits seem called for. 

(a) In the case of accidental profits, the correspondence be- 
tween service rendered, and reward received is obviously very 
slight. Profits do not in this case tend to express the marginal 
significance of the receiver's contribution, 

(b) In the case of monopoly profits, there is doubtless fairly 
close correspondence between the reward and the marginal sig- 
nificance of the supply of service actually rendered, but not 
between the reward and the marginal significance of the supply 
of service which would naturally he rendered. The monopolist 
by limiting the output of his product raises its marginal utility, 
and so its price, above the marginal utility which said product 
would naturally have. In doing this, he obviously raises his own 
profits above the amount which would express the marginal 
utility of his services, were no limitation set on their output. 

To the above account of this case of monopoly, however, one 
qualification must be added. The monopoly which temporarily 
exists may have been anticipated, and hence may have been one 
of the conditions which induced capitalists to undertake the 
industry in question when they would not otherwise have done 
so. In such case, we may say the monopolistic output is the 
natural one and so the case comes fully under the service-value 
principle. Cases of this sort are supplied by the legal monopoly 
of patents, copyrights and franchises, and by the quasi-monopoly 
of new enterprises. Here the extra-profit does not correspond 
merely to the higher valuation by supra-marginal buyers of the 
service rendered, but also to the additional service. For, surely, 
there is an additional service when men undertake to try out 
the feasibility of a new enterprise, — giving the public an oppor- 
tunity to find out the real utility of the service or commodity 
said enterprise supplies. 

In spite of this qualification of our first statements, the stu- 
dent must not suppose that economists are disposed to affirm the 
service-value principle for monopoly. In general, the presence 

309 



PRINCIPLES OF ECONOMICS 

of monopoly at any point more or less seriously interferes with 
the realization of said principle; and, assuming for the moment 
that -said principle has a valid claim to the place of legitimate 
ruler for any economic order, then monopoly, if necessary or 
permitted, ought to be regulated or controlled in the public 
interest. 

(c) The case of Enterprise Profits has been more or less 
anticipated in the preceding discussion of monopoly profits. Such 
profits have not a little resemblance to prises. Many persons 
get nothing; a few get large rewards. Under these conditions, 
we can scarcely expect profits to express with great precision 
the contribution of the profit-receiver. Yet we should not, on 
the other hand, imagine that the two are entirely divorced. 
Opportunities for exploiting novel enterprises are constantly 
arising; competition for such opportunities is kept fairly brisk; 
the goods produced must command prices fairly expressing their 
marginal utility; the marginal contributions of the other factors 
are at the same time being more or less fully determined in 
other fields ; and it seems not unreasonable to assume that the 
residuum of product — which constitutes profits — is properly cred- 
ited to the entrepreneur as his contribution. 

(d) That Ordinary Profits of the necessary sort, if they 
exist at all, tend to express the marginal contribution of the 
entrepreneurs does not seem to need additional discussion. Here 
the, elements of change and uncertainty are reduced to a mini- 
mum ; so that the economic processes which tend automatically 
to secure each factor a share representing its contribution to the 
joint product, have ample time to work themselves out. 

(e) The Differential variety of Ordinary Profits will surely 
express with considerable precision the corresponding contribu- 
tion of the entrepreneur, since by its very nature it grows out 
of the superior productivity of that entrepreneur. This is seen 
by analyzing the process by which such profit arises. The price 
of' the product involved is fixed at cost (including necessary 
profits) to the marginal entrepreneurs. A higher grade entre- 
preneur can now get differential profits only by reducing cost 
per unit and so getting a bigger surplus out of a price already 
fixed. Now this condition of reducing cost he fulfils because 

for some reason he is more efficient, creates more utility ; and 

310 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

the size of the surplus thus produced will depend on the degree 
to which he is more efficient, i. e., the difference between him 
and the marginal entrepreneur in respect to productivity. 

4. Do Profits Submit to the Disutility Principle? 

It is obvious that a negative answer is necessary in the case 
of Accidental and Monopoly profits. The same answer seems 
natural in the case of Differential profits, though this is not so 
certain. If disutility comes into any case of value, it is because 
the failure of value to cover that disutility causes production to 
fall off, and so compels price to rise till said disutility is cov- 
ered. If the usual analysis which finds price-determining dis- 
utilities only in the case of marginal producers, is correct, 
differential profits would be a sort of producers' rent, — a sur- 
plus usually exceeding the corresponding disutility.* 

Passing to the case of Necessary profits, it seems certain 
that these must express with fair precision the marginal disutil- 
ity involved in supplying the entrepreneur service. (1) The 
demand of the public must insure for the product involved a 
price high enough to cover the disutility undergone by the 
entrepreneur; since otherwise production will cease, supply will 
fall off, and so price will rise. (2) The competition of entre- 
preneurs will keep price from going higher than the above point ; 
since their numbers can be recruited at all times from those 
capitalists who merely furnish waiting power, i.e., lend their 
capital rather than invest it. 

In the case of Enterprise profits, also, correspondence be- 
tween the disutility involved and its reward seem necessary 
from the same reasoning, though here the correspondence is 
less precise. 

Note. _ It does not seem a valid objection to the application 
of the disutility principle to this case of enterprise profits to 
say that there is too much chance involved in these cases to 
insure any particular result; — the price of the product may fail 
to cover, not only the peculiar disutility of the entrepreneur, 
but also even the ordinary outlay for material, wages, etc. ; 
while, on the other hand, it may cover all that outlay and give 
a surplus large enough to insure alm.ost any conceivable risk 
several times over. This reasoning quite fails to recognize 

*It_is possible that, in respect to the particular disutility under con- 
sideratiori— responsibility-taking — the more efficient entrepreneur is really 
the marginal one, i. e., the one to whom disutility is greatest. In that case 
our reasoning could not stand. 

311 



PRINCIPLES OF ECONOMICS 

the real nature of the responsibility-taking disutility. That 
disutility is not expressed by the term "insure." According to 
that theory risk comes in, not as a chance of loss to be covered 
by insurance, but as a chance of loss not to be covered at all. 
The taking of such chances involves a disutility. To induce men 
to incur that disutility, a prize, or bonus, of larger or smaller 
magnitude, must be attainable in case of success. The size of 
that bonus is roughly proportioned to the risk, though the unit 
of variation is very different for different races ; and, having 
been fixed, it must be covered in the price of the product. 

5. Do Profits tend to Disappear? 

A rather noteworthy fact in recent economic discussion, 
particularly in this country, is the manifestation of a disposition 
to hold that profits — pure profits — tend to disappear. The argu- 
ment for this contention moves along two general lines, (a) 
It is afiirmed that pure profits, assuming them to be paid for 
risk-taking, will necessarily disappear with the elimination of 
risk from industrial affairs ; and such elimination is steadily 
proceeding through the increase of knowledge, forethought, in- 
vention, etc. (b) Secondly, it is claimed that the disutilities 
correlated to profits are disutilities which plenty of men, particu- 
larly in America, are quite willing to assume without reference 
to an economic reward. In support of this contention its ad- 
vocates bring forward the consideration that the desire for 
power, the craving for better social standing, the gambling spirit 
which eagerly improves the opportunity to take chances, — all 
these unite to make men who have the necessary capital and 
capacity willing to undertake the responsibilities of production, 
even though they expect to get nothing more than ordinary 
interest on their capital and ordinary wages for their labor 
contribution. 

In reply to the first of the above arguments, it seems sufficient 
to declare that the complete disappearance of risk, chance, un- 
certainty from industrial affairs, if not quite impossible, is 
certainly so remote that it can not properly be made the basis 
for any affirmations with respect to the present order. Some 
centuries hence we may have become able to predict the weather 
for a year in advance with absolute precision, but we shall 
still have to reckon with the uncertainties due to human folly 
and caprice. 

The second line of argument is less easy to answer, yet will 

312 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

not, I think, carry conviction to most persons. The first two 
of the three considerations given above as making men willing 
to assume the responsibilities of production, apply to hardly 
more than a small minority of the entrepreneur class of our 
day, — the small individual or partnership entrepreneur who com- 
bines in himself the functions of capitalist, manager, and entre- 
preneur ; for, under the corporate organization of industry, 
power goes to salaried officials, and the social position of bond- 
holders is surely as good as that of stockholders, assuming their 
investments to be equal. But, if there is any considerable section 
of the entrepreneur class with whom these non-economic motives 
would not suffice, — who would insist on a greater economic return 
for taking responsibility than for simply lending their capital — 
then, profits would surely have to be paid. 

The third of the considerations brought forward to show 
that men will undertake the responsibilities of the entrepreneur's 
position without an economic reward, — viz., the gambler's desire 
to take risks — contains the old confusion of ideas which has 
already been commented on more than once. It is undoubtedly 
true that men are so ready to take risks, when a possible great 
prize is in sight, that they do not as a whole class, have to be 
remunerated for taking that risk. In other words, if all the cop- 
per producers of the world spend 500 million dollars worth of labor 
and capital getting out the product, it is not necessary that said 
product should be worth 500 millions plus something for the 
risks taken. On the contrary, that product will probably be 
worth considerably less than its labor and capital cost, say 400 
millions. But all this is beside the point. The real issue con- 
cerns, not the whole class of entrepreneurs interested, but only 
those upon whose conduct the output actually supplied depends, 
i. e., the successful entrepreneurs. Do these persons have to 
get profits? Surely they do, else there would not be this gamb- 
ler's eagerness to assume the risks of the business. The proper 
test for determining whether profits of the sort under consider- 
ation, i, e., a remuneration for risk-taking, really exist, is this : 
Does society have to pay a higher price for a particular com- 
modity or service than it would have to pay if risk were 
eliminated? Surely there can be but one answer to that question, 
viz., the affirmative one> 

31^ 



PRINCIPLES OF ECONOMICS 

6. Profits as Affected by Changes in the Value of Money. 

In an earlier discussion, it was brought out that the value of 
money itself may change and, so, general changes in prices may 
take place without reference to the conditions ordinarily govern- 
ing the value of each commodity. Thus, under the paper money 
standard of civil war times, there was a general rise of prices, 
i. e., a fall in money, in the United States. So, for many years 
following 1873 there was a general, though gradual, fall in prices, 
i. %, a rise in money, affecting most or all of the Western 
nations. Much more rapid ups and downs mark the periods 
immediately preceding and following commercial crises or pan- 
ics. There has naturally been much debate as to how far such 
movements influence distribution. At this point, our particular 
interest in these changes respects their influence on profits. At 
first thought, perhaps, the student is inclined to say that of 
course such changes influence profits. If a merchant has paid 
$100,000 for a stock of goods, and, because of a universal and 
simultaneous fall in prices, their value declines to $60,000, how 
can anyone deny that the merchant is losing $40,000? This 
sounds plausible, but is in fact a very evident fallacy, though 
a common one. A universal and simultaneous fall in prices of 
40 per cent raises the buying power of $60,000 till it is just as 
great as was that of $100,000. Supposing no other change in 
conditions to occur, the merchant in question neither gains nor 
loses as a result of the fall in prices. But, while the sort of 
price change above supposed, i. e., a price change wherein all 
prices, including those of labor, move up or down simultaneously, 
has of itself no influence on profits, the general price changes 
of actual life probably do, in most cases, have some influence. 

(a) In so far as entrepreneurs are debtors, they gain by a 
general rise in prices but lose by a general fall. The money 
significance of their debts does not change with prices, but that 
of their product does. 

(b) It is probable that general price movements which take 
place with considerable rapidity affect profits to a considerable 
degree. This is because such movements are felt by commodi- 
ties more promptly than by labor services and so raise or lower 
returns more than they raise or lower costs. 

314 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 
Section I. Special Consideration of Rent. 

1. The General Nature of Rent has, perhaps, been sufficiently 
emphasized in earlier connections. As generally understood by 
economists, it is the return which accrues to the owner of land 
conceived as independent of improvements, though it is admitted 
that, in some cases, separation is impossible, — the improvements 
necessarily sharing the economic fate of the land. 

2. The question whether land submits itself to the Service- 
value or Productivity principle is quickly answered in the affirm- 
ative. Land, being a factor the supplying of which is not, 
generally speaking, conditioned on man's choice, is a fixed- 
supply good, and hence the process whereby each factor in 
joint production is automatically given a price expressing its 
marginal significance, would, in this case, work itself out with 
exceptional ease. The result is, further, more fully assured 
because of conditions in large measure peculiar to land, (a) 
First, land naturally grades itself into classes shading, by almost 
insensible steps, from very high to very low efficiency, (b) 
Secondly, competition among these different classes is assured, 
even when the uses to which they are put are very diverse, 
from the fact that, while not all the members of one class cah 
be utilized for the purposes to which the adjacent classes are 
devoted, yet enough can be so utilized to keep these effectively 
competing. (Compare the case of two large reservoirs with a 
small channel connecting them,— will the water in them have 
one level? Read Seager, pp. 206-211.) (c) Up to the present, 
anyhow, there are not a few inferior grades of land which are 
not yet put to use, because human need has not yet compelled 
their utilization. Under these conditions, there will naturally 
be some lands to which, though they are put to use, no part 
of the product is credited ;— other pieces as good or only slightly 
inferior being unused and so available to replace these, the case 
is lacking in that scarcity which is necessary to induce us to 
impute any portion of the product to a particular factor. (Com- 
pare the case of the charcoal and sulphur in the powder illus- 
tration on page 217.) At the same time, no rent will be paid 
for these lands; since the competition of the lands which are 
not used at all would hinder the owner of the marginal land from 
getting rent for his. But it is obvious that, if a certain amount 

315 



PRINCIPLES OF ECONOMICS 

of labor and capital will get, say, 11 bashels of wheat in a com- 
bination wherein the 11 bushels are all credited to the labor 
and capital while the same amount of labor and capital can get 
18 bushels from another piece of land, the 7 bushels extra will 
be credited to the land as its product. At the same time, it is 
plain that the competition of tenants to get control of this 18- 
bushel piece will put the 7 bushel difference and no more into 
the hands of the land-owner as rent. Thus, we see that the 
portion of the output which is naturally credited to the land 
as its product and the portion which inevitably goes to the 
land-owner as rent are the very same amount. That is, rent 
necessarily corresponds with great precision to the product 
which the rent-bearing land gives off. 

3. Does Rent submit itself to the Disutility principle? This 
question presents greater difficulties than our last one. If it 
means: Must rent be what it is because the marginal disutility 
of supplying land uses is what it is?, our answer must of 
course be in the negative. As already explained, the disutilities 
involved in being a rent-receiver, i. e., a land owner, are deriva- 
tive, not original. They are what they are because the income 
is what it is, not the reverse. The rent of land does not have 
to adjust itself to the original disutility of supplying land. But, 
if we mean by our original question merely this : Must the 
disutilities involved in being a rent-receiver, i. e., a land owner, 
and the rent received be so related that said disutilities are, 
broadly speaking, expressed by said rent?, the answer is surely 
an affirmative and one not greatly qualified. Under normal con- 
ditions the market price of any piece of ground will approxi- 
mately equal the capitalization of its net income ; in consequence, 
persons desiring to become rent-receivers will be obliged to 
invest their full capital in said land just as if it were a producible 
commodity; and so gaining the position of a rent-receiver will 
normally involve assuming the ordinary capitalistic disutilities, 
abstinence, waiting, and risk-taking. Further, this process of 
capitalizing the income of land will almost certainly work itself 
out in such a way that the income pretty closely expresses the 
disutilities created. This is of course inevitable in cases where 
the element of change is very small. That is, when the dis- 
utilities are reduced to abstinence and waiting (if these should 

316 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

be distinguished), they are very precisely expressed in the income 
received.* In those cases, however, where much change is in- 
volved, the correspondence of income and disutility is of course 
much less perfect. But it is by no means wanting even here. If 
the prospects of change do not involve serious uncertainty, the 
case is little different from an unchanging one. A pretty certain 
prospect of increasing income will cause a corresponding rise 
in the capitalization, and vice versa. Where there is much un- 
certainty and, so, much risk, this fact will be treated as a 
diminution of the net income, and, in consequence, the capitali- 
zation and, so, the disutility assumed will be lowered. 

Section I. Real vs. Apparent Incomes. 

Up to this point in our discussion of incomes, we have 
ignored altogether the possibility of a discrepancy between the 
seeming income and the real one. But a very little reflection 
will show that there is such a possibility. In the great majority 
of cases, apparent incomes are in the form of money. But the 
buying power of money may be, and surely is, very different in 
different places and in the same place at different times. Further, 
to get the really effective income which a man enjoys, as such 
words are commonly understood, various other additions or de- 
ductions have to be made, even if we have made allowance for 
the differences in the purchasing power of money. Accordingly, 
it seems necessary to call attention to certain discrepancies be- 
tween apparent and real incomes. 

1. Income as Affected by Prices. 

(a) Any cause which tends to raise the prices of partic- 
ular goods tends thereby to lower the incomes of all consumers 
of such goods other than those consumers who are also pro- 
ducers of said goods. 

One of the most familiar applications of this is the case of 
monopoly. The greatest significance of monopoly as modifying 
distribution is in that, by raising prices, it reduces the volume 
of our real incomes, i.e., the sum of goods which we may enjoy. 
Another case illustrating how causes which affect the prices of 
particular goods lower real incomes, is the indirect tax which, 
by adding to the outlay of the producer, causes price to rise. 

*0f course this applies only on condition that the land has changed 
hands by purchase since the existing rent came to prevail. 

317 



PRINCIPLES OF ECONOMICS 

A noteworthy feature of this case is the fact that a tax on 
imports makes a higher price, not only for the imported part of 
the goods consumed, but also for the part produced at home. 
Still another important cause which modifies real incomes by 
affecting particular prices is improvement in methods of pro- 
duction whereby costs and so prices are reduced. 

(b) If for any cause there is a change in the general level 
of prices, this fact is likely to modify more or less the real 
incomes of people. 

Some pages back we pointed out that changes in the general 
price level are likely to affect favorably or unfavorably one sort 
of income,— profits. The process brought out in that case di- 
rectly affects money income. But such changes in general prices 
may also modify real, as compared with money, incomes. A 
general rise in prices obviously lowers the buying power of a 
given money income. Now, if particular money incomes are 
absolutely or relatively fixed, the corresponding real income is 
reduced. The worst cases are those of annuitants, pension- 
receivers, and persons depending on contractual interest for 
their incomes. Next come the case of persons whose income 
consists of fees; for these, if not legally fixed, are anyhow 
slow to change. Salaried persons are the next to suffer ; for 
salaries as a rule change very slowly. The case of wage- 
earners is hardly less serious ; since the rate of wages responds 
only with difficulty to changing conditions. Thus, the upward 
price movement consequent upon the paper money inflation of 
the American civil war reached its maximum for commodities 
in 1865, but for labor the, date was 1872. 

2. Incomes as Affected by Taxation. 

It is evident that, if after a man has come into possession 
of his money income, government either directly or indirectly 
takes from him some portion of that income, his final income 
of gratifications of the ordinary sort is thereby qurtailed. This 
must not ; be understood as implying that payments to govern- 
ment are in no sense correlated to a real income to the tax- 
payer. The expenditures of government are surely of advan- 
tage to the citizen ; and, for some purposes, the citizen ought to 
think of his contribution to that expenditure as a thoroughly 
legitimate and important part of his personal budget. Still, it 
is quite impossible to deny that we can not rationally describe 

318 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

payments to government as the purchase price of services ren- 
dered, in the sense that we use these terms when speaking of 
payments to the grocer or the drygoods dealer. It is quite 
impossible to form any rational theory of the ethics of present- 
day taxation except by recognizing that taxes constitute a con- 
tribution which it is our duty to make, and the government's 
duty to exact from us, in order that certain general, public, 
ends may be accomplished, — ends in which it is often extremely 
difficult to trace the particular personal advantage of the tax- 
payer. For our present purpose, therefore, it seems legitimate 
to look on taxation as cutting down our real incomes. 

Starting from this viewpoint, we should probably find that 
taxation tends to modify somewhat the distribution which would 
naturally result from the free, spontaneous working of economic 
forces, but that its influence would be smaller than at first 
thought one might expect. In fact, a large body of economists 
would be disposed to say that a system of taxation which con- 
tinued substantially unchanged throughout long periods would 
have almost no modifying effect on distribution. Such a system 
would simply be one of the fundamental conditions under which 
the service-value principle would work itself out. But, how- 
ever this may be, we all know that systems of taxation can not, 
and do not, remain unchanged for indefinite periods. Now, no 
one pretends that the shifting of taxes so as to bring about the 
same relative distribution as would have prevailed without them, 
is an easy matter which can be accomplished in a few months 
or anyhow in a very few years. Rather it may consume the 
life of a generation. This being the case, it is of importance to 
ascertain some of the effects on distribution which sooner or 
later will be felt, and, if desirable, guard against these. We 
will here call attention to only two or three considerations. 

(a) It is usually admitted that indirect taxes, e.g., import 
duties and excises, if levied in such a way as to be greatly 
productive, fall relatively with greater weight on small incomes 
than on large ones. 

(b) A general property tax affects the incomes of persons 
owning visible property much more than the incomes of owners 
of bonds, stocks, etc. 

(c) A land tax of long standing does not constitute a bur- 
den on any private income, being in effect a rent-charge paid 

319 



PRINCIPLES OF ECONOMICS 

to the government as part owner of the land. (The present 
owner did not buy, and does not own, an exclusive property in 
the land.) 

3. Effective or Consumptional Income as Contrasted with 
Absolute Income. 

We have already noted various deductions which must be 
made from, or additions which must be made to, one's apparent 
income before we can know what the real income is. 
Another set of deductions or additions are suggested by setting 
consumptional over against absolute income. When people speak 
with indignation of the excessive incomes of the very wealthy, 
they usually are directing their attention to the fact that people 
of wealth enjoy so much more than their neighbors of the good 
things of life, fine foods, beautiful furniture, automobiles, travel, 
etc. In short they have in mind their consumptional income, — 
what they consume, in the popular meaning of the word, i.e., for 
their immediate gratification. Now, it is hardly necessary to 
say that, when incomes are conceived this way, there is much 
less difference between those of the rich and poor than seems 
on the surface to exist. The man whose apparent income is, 
say, $100,000 consumes in the ordinary sense perhaps only 
$20,000 worth of goods, the remaining $80,000 being invested 
and devoted to further production. Of course this new invest- 
ment will increase his absolute income. But what if it does? 
He very likely does not care to alter materially his habits of 
living. He, therefore, has no use for the increase except to 
invest it in turn. Thus, as respects his total of income, with 
the exception of $20,000 a year, the rich man in question may 
be conceived as a sort of steward for society at large, paid a 
good commission indeed, but after all only a steward. His 
income in the ordinary sense, his enjoyment of goods, is not 
100 times that of the man who earns $1,000 and spends it all 
on every day consumption, but only 20 times. 

The above discussion brings out the point that if we are trying 
to realize the real, effective difference in the incomes of the 
rich and the poor, we must for most purposes deduct from 
the incomes of the rich the part put into further production. 
As a complement to this point it is to be noted that, in order 
to realize just how great is the real, effective income of the 
poor, we must add a large number of gratuitous and semi- 

320 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

gratuitous goods which under modern conditions are supplied 
to them. Especially notable are , the means of education and 
amusement which are furnished so liberally at public expense. 

Section J. Incomes as Affected by Non-Economic Forces. 

We have seen that incomes generally are determined by the 
laws of value or price, i.e., by economic forces. But no one 
doubts that other forces, custom, altruism, nepotism, fraud, etc., 
come into the case, and, indeed, play a very large part. Some 
of these forces work to increase the inequality natural to a com- 
petitive order; others work to diminish that inequality. 

Among the non-economic forces tending to diminish inequality* 
or, as most people would say, to improve on a strictly com- 
petitive order, we have all sorts of employers' philanthropies, 
profit-sharing, co-operation, a vast system of charities, large en- 
dowments to meet all sorts of needs, and so on. 

Over against these, leading to an intensification of the in- 
equalities natural to the present order, we have a great array 
of powerful forces, predatory competition, favoritism, breach of 
trust, nepotism, stock-jobbing, frauds of all kinds, and so on. 

Section K. The System under which Possessions are Dis- 
tributed. 

It is evident that three of the four economic incomes, profits, 
interest, and rent, connect themselves with property, — are de- 
rived from property. It follows that back of the determination 
of incomes, immediately considered, must lie the distribution of 
property. We understand the theory of these incomes only in 
part, if we stop with the study of them as put off by land and 
capital. We ought to go deeper and explain the distribution of 
ownership in land and capital. At present it is out of the ques- 
tion for us to do this at all adequately; but a few comments 
seem to be demanded. 

1. First, in so far as possessions are derived from one or 
more of the four regular incomes, and this covers not a little 
of the case still, it must be remembered that large properties can 
be built up only through saving. In this respect there has been 
no essential change from primitive times. Thrift, economy, is 
still the essential condition of great wealth, great possessions. 
With fortunes well started, thrift does not of course involve 
great privation. Nor was this ever the case; it is only the very 

321 



PRINCIPLES OF ECONOMICS 

beginnings of a fortune which involve such privation. But 
thrift, economy, keeping within one's income, must always be 
essential ; for the arts of consumption have never failed sub- 
stantially to keep pace with those of production. Wanton ex- 
travagance can never consist with the building of great fortunes. 
Of all the regular sources of income, profits have in our day 
doubtless had the largest share in the creation of fortunes. This 
is using profits quite broadly to include all the gains which go 
to the people who assume the risks of ownership. Some of the 
most important cases are (a) profits derived from the exploita- 
tion of stores of natural wealth, (b) profits from the exploita- 
tion of new inventions, (c) profits from monopolies, partial or 
complete, (d) profits from unearned increments, increases in 
values due to changes for which the owners of the properties in 
question are not responsible, and (e) profits from industrial re- 
organization. 

2. In the second place, the maintenance of great fortunes 
must always depend in considerable measure on the practice of 
thrift. This, of course, does not mean serious privation of any 
sort, but only a firm adjustment of expenditure to income. 
Reckless extravagance can dissipate the greatest of fortunes. 
This fact has always been accounted a sufficient safeguard 
against the dangerous concentration of wealth made possible 
through inheritance. The extravagance of heirs, it is argued, 
can always be depended upon to dissipate extraordinary wealth 
in one or two generations. This generalization has probably 
been a great deal overstated. It would not be difficult to point 
out families which have retained wealth for several generations 
and bid fair to continue the experience. 

Note. The ordinary view of the case seems to overlook one 
phase of this dissipation of fortunes which deserves comment. 
Doubtless the diminished inequality of fortune, the passage of a 
great productive property into abler hands, as well as other 
results of the supposed dissipation, are of real advantage to 
society. But it should not be forgotten that these have a cost. 
There is a real squandering of wealth, a reckless, wanton, con- 
sumption of society's resources, not a mere shifting of property 
rights. The spendthrift destroys as m,uch wealth as that which 
he transfers to others, save in so far as he is cheated. 

3. Inheritance always has played, and still plays, a very great 
part in determining the distribution of possessions. Obviously 

322 



CHAPTER XII. SYSTEM OF DISTRIBUTION. 

its significance is chiefly dependent on the particular laws and 
customs which obtain in any time and place. The general tend- 
ency of present day legislation is to diminish the part played by 
inheritance. 

(a) In earlier times, entail was used to maintain an unequal 
distribution of property. Law, or custom as binding as law, pro- 
hibited the breaking up of estates by alienation through sale 
or gift. 

(b) Where entail is no longer permitted, settlement may 
accomplish something like the same result; though recent legis- 
lation has provided for the practical nullification of such settle- 
ment. 

(c) Primogeniture^ exclusive inheritance by the oldest child, 
is still the order of things with the noble families of England 
and, of course, tends to perpetuate the existing inequalities more 
than would subdivision among several children 

(d) In contrast with entail, settlement, and primogeniture, 
the democratic ideal as represented by modern France insists on 
equal division among the children. This is no doubt a great 
improvement, assuming that the tendency toward inequality is 
undesirable. 

(e) In our day the legislation which seems likely to mod- 
ify most conserably the natural distribution of wealth is the 
inheritance tax. This has already been developed to a very con- 
siderable magnitude and is everywhere being carried further. 
In Great Britain, it amounts to nearly 10 per cent in the case of 
direct heirs and to about twice as much for the more remote 
collateral heirs. 

4. In the United States one of the most important sources 
of great fortunes is the public — governmental — grant. Under 
heading 1 above, it was said that profits derived from the 
exploitation of stores of natural wealth played a large part in 
building up fortunes. But the opportunity to obtain such profits 
obviously turns on the ownership or control of land and the 
latter in turn has largely been obtained through governmental 
munificence or folly in granting such land. Here we have one 
of the greatest abuses in American industrial evolution. We 
have squandered the patrimony of many generations. The "weak- 
ness of government in a new and republican nation, a careless 
overestimate of our resources, preoccupation each with his own 

323 



PRINCIPLES OF ECONOMICS 

affairs, — these and other conditions have combined to make 
possible a reckless' profligacy in the disposition of our natural 
resources which future generations will find it hard to compre- 
hend and still harder to forgive. 

It should doubtless be admitted that in some measure public 
liberality has been justified as part of the price of our extra- 
ordinarily rapid development. 

5. There can be no doubt that fraud of varying kind and 
degree has been an important factor in determining the distri- 
bution of property, possessions. Here we have in mind, not the 
fraud which enlarges income and which would therefore make 
possible the enlargement of possessions, but rather the fraud 
which directly adds to possessions, e.g., getting control of 
valuable timber lands belonging to the state by illegal means. 
Under the preceding head, we noted the absurd liberality of 
government in turning over public property of incalculable value 
to private persons for little or nothing. The evils of such a 
policy have been increased in no small degree by fraudulent 
practices. By the collusion of legislators and public officers, 
the patrimony of the state has been stolen on a gigantic scale. 

Quite as notable, perhaps, has been the stealing of franchises 
yielding hundreds of millions. 

Even in the lesser relations of ordinary business, fraud has 
played no inconsiderable part. Swindling of partners, freezing 
out weaker stockholders, violating trusts, etc., these and many 
other forms of fraud are constantly practiced. 



324 



CHAPTER XIII. 

A CRITIQUE OF THE EXISTING ECONOMIC ORDER. 

We have now reached the end of our purely scientific study 
of the economic phenomena of the present order. If we were 
deahng with a group of phenomena quite removed from human 
control, it would be natural to stop at this pomt. But we hardly 
need say that, with respect to economic phenomena, no such state- 
ment could properly be made. The present economic order is in 
greater or less measure the product of human arrangements. 
As such it must be presumed to be formed with more or less refer- 
ence to the accomplishment of ends. Doubtless one may easily 
exaggerate the power of individiials, or of society as a whole, 
to alter the system in fundamentals. But so long as this power 
exists in any degree, indeed so long as people commonly believe 
that it exists, students of economics will feel called upon to con- 
sider the fitness of the present order to attain the ends for which 
it must be presumed to exist. To this, however, some may object 
that, although such a problem as that indicated is surely presented 
by the situation, still the economist as such is not called on to 
attempt its solution. Such persons would perhaps say that eco- 
nomics, being a science, has to do only with what is, not with 
what ought to be ; consistency, therefore, requires the economist 
to leave the critique of the present order to some other class of 
persons, say, the sociologist or the publicist or the philosopher. 
There is no doubt force in this contention. It is to be remem- 
bered, however, that there is a degree of deference to logical 
consistency which savors of pedantry. In every field there arise 
problems having a mixed character, — problems dependent for 
their solution on data derived from various sciences. These 
problems must be discussed somewhere, which means that one, 
at least, of the sciences interested must transcend, in some meas- 
ure, its natural boundaries. Now, it would seem that the science 
which we would naturally choose for this office is that one from 
which the larger number and the more difficult of the data neces- 

325 



PRINCIPLES OF ECONOMICS 

sary to a solution must be obtained. In the case before us, this 
condition is surely realized by economics. 

In further support of this contention that economics should 
undertake the task of ascertaining whether, and how far, the 
present economic order attains the ends for which it exists, we 
may remark that such practice is on the whole in accord with 
tradition. Economists, whatever their initial professions, have 
seldom failed to discuss the working of the system from the 
teleological standpoint, and even to argue for or against proposed 
changes, and it is probable that the instructed public give more 
weight to the verdicts of economists in respect to these matters 
than to those of any other class. 

Note: In maintaining the foregoing contention, we do not 
mean to suggest that moralists, sociologists et al. should be 
estopped from discussing how far the present order is a success 
or a failure. We merely wish to insist that the economist can 
properly enough essay this task. 

In the preliminary account of the existing order with which 
this course began, that order was represented as a coherent, 
rational whole, — a system having different parts devoted to dif- 
ferent functions, all co-ordinated into a great harmonious totality. 
At the same time, however, it was represented that the organiz- 
ing and regulating of this great totality was not conscious, but 
spontaneous, automatic. Further, we saw that the particular 
economic process having most part in automatically creating 
the great whole and regulating its operations, is exchange. Still, 
again, it was brought out that the particular part, element, in 
exchange which has most to do in regulating the organization as 
a whole, is value, price. More particularly, it was explained that 
it is price chiefly which determines what things shall be produced, 
how things, when produced, shall be utilized, and what propor- 
tion of the total product shall fall to the different participants 
is socialized production. In the present chapter we try to answer, 
not exhaustively, but with greater fulness than heretofore, the 
question : Hoiv far is this automatically regulated economic sys- 
tem a success in attaining the ends for which it must be supposed 
to exist? Does it secure fairly satisfactory results — as good 
results, anyhow, as it is reasonable to look for — in respect to 
production, consumption, and distribution? 

In view of the tone of many previous allusions to this ques- 

326 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 
tion, it is hardly necessary to say that the answer offered in this 
chapter is on the whole an affirmative one. Broadly speaking, 
we look on the existing economic order as measurably realizing 
the ideals which, considering the limitations of human nature, 
it is reasonable to demand from such a system. But in taking 
this position we wish to disclaim in the most emphatic language 
any intention of representing the present order as a perfect one, 
either theoretically or practically. Its ideals are below the highest, 
though necessarily so as we think; and its practice is at many 
points far below its ideals. Many of its failures grow out of the 
limitations of human nature; but not a few are needless,— can 
be avoided. Increased interference with the actual working of 
things, both through private and governmental initiative,— if for 
no other purpose than to eliminate elements which are, and always 
have been, inconsistent with the system,— is imperatively de- 
manded. Further, there can be no doubt that a degree of gov- 
ernmental interference which goes much beyond this, which 
limits sharply the free working of those conditions which are 
most characteristic of the present order, ought to be, and will be, 
forthcoming in the near future. Whether in the interest of 
society as a whole or of those individuals on whom the existing 
system presses too hardly, we shall doubtless see a more exten- 
sive resort to governmental initiative, a greater limitation of the 
rights of property, a further restricting of the rights of inherit- 
ance and bequest, a distribution of tax burdens far more favor- 
able to the poor, public provision for old age pensions, and so on. 
In a word, when we defend the existing order we merely mean 
to affirm that that order is in its main outlines substantially 
sound, fitted to attain the reasonable ends for which such an 
order exists. Looked at broadly, it shows itself to be highly 
efficient and as much in accord with our moral ideals as we 
could expect in view of human weakness, folly, and wickedness. 
The general plan of exchange-cooperation, involving private 
rather than public initiative, characterized by private property 
in capital and, for most purposes, in land, with production, con- 
sumption, and distribution regulated in general through a price 
resulting from free economic action, is more likely than any 
fundamentally different scheme to work in a measurably satis- 
factory fashion. Increased regulation and a more liberal admix- 

327 



PRINCIPLES OF ECONOMICS 

ture of socialistic elements may improve things ; but the general 
system, the main framework, is sound and, as human affairs 
go, adequate. 

Section A. The Present Order and Production. 

It would probably be admitted by well-nigh every one that, 
?n respect to production, the present system works fairly well, — 
anyhow is less defective than in respect to distribution. The 
socialist, it is true, lays considerable stress on certain deficiencies 
at this point ; but most scientific students would probably con- 
sider his criticisms much exaggerated. Even the socialist would 
admit that a better case for the defense is possible here than 
elsewhere. 

The chief characeristics which we naturally demand in a pro- 
ductive system, if it is to be adjudged reasonably satisfactory, 
are: (1) that its product should be large — the largest possible 
from the resources available; (2) that the said product should 
be good, — the best possible, considering the resources; (3) that 
it should be adjusted to wants; and (4) that production as a 
process should.be as free as possible from marked irregularities, 
perturbations. 

How far does the present system display these characteristics? 
Beginning with the fourth, it must be admitted that, at the pres- 
ent time, our system is not very satisfactory. It is a familiar 
fact that production is subject to marked, almost violent, fluctu- 
ations, which naturally group themselves into the so-called indus- 
trial cycle : depression, recovery, increasing activity, normal 
activity, over-trading, crisis, collapse, depression, and so on. The 
claim of the socialist that public initiative would almost, if not 
quite, eliminate this sort of thing is surely a fairly reasonable 
one. Anyhow, socialism would be certain to work better at this 
point than does the present system. We do not, however, admit 
that this settles the matter. The fact is that the industrial cycle, 
in its serious forms, is a comparatively modern disease, — not 
much more than a century old. Further, even socialists admit 
that much has already been done to bring it under control. 
America, for reasons easy to trace, is still much subject to 
attack. But England, the original home of great panics, has had 
no serious crisis since 1866. In short, the leaders of industry 
are learning to control things suiPSeiently to safeguard against 

3^8 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

this trouble or, anyhow, to palliate greatly its evils. Accordingly, 
it would surely be foolish at the present time to pronounce a 
verdict against the present order on account of the defect in 
question. 

Turning, now, to the first three of the characteristics which 
can properly be required from a good productive system, it 
seems certain that a favorable verdict must be given for the 
present order. If we are looking for an order which insures 
abundant products, good products, and products which corre- 
spond to demand, the present one can surely give a good account 
of itself, — far better, probably, than could any substitute which 
should depend on public initiative. Take the first two matters, 
abundance and goodness of products. As respects fitness to 
secure these results, the present system supplies conditions which 
seem almost theoretically ideal in that it makes each man's 
income conditioned upon the price of his contribution, then estab- 
lishes the freest possible market for those particular contribu- 
tions which are bought and sold^abor services, .capital services, 
and land services, and, finally, in respect to the remaining factor 
— responsibility-taking, — it permits the almost untrammeled initia- 
tive of the individual. Now, making incomes dependent on con- 
tribution and maintaining a free market for land, labor, , and 
capital services means that these are forthcoming, in so far as 
this is dependent on human choice, in the greatest possible abund- 
ance, and that they are inevitably put to the most profitable uses, 
i. e., that they are assigned to the places, combinations, where 
they will add tnost to product. In like manner, the regulation 
of income in accord with contribution, combined with free private 
initiative in respect to undertaking, means an initiative the most 
alert, bold, energetic, and informed that one can well imagine. 
It is quite incredible that government should supply an initiative 
at all comparable in these particulars. 

The above verdict with respect to the productive efficiency 
of the present order is concurred in by almost all economists. 
Yet perhaps a moment's consideration should be given to the 
opposing contention of socialist critics that this order is not even 
productively successful. In support of this idea they bring for- 
ward three considerations chiefly : the wastes of competition-, the 
idleness of the parasitic classes, and the sacrifice of utility to 

329 



PRINCIPLES OF ECONOMICS 

value. In respect to the first of these it is to be said that there 
are undoubtedly wastes in a system of free private initiative, — 
though their amount is grossly exaggerated, — ^but, in the opinion 
of the economist, this so-called waste is merely the cost of a 
rarely efficient initiative, and a low cost at that. For all students 
of business organization agree that the monopolistic and quasi- 
monopolistic business units are much less efficiently organized 
today than are the units exposed to free competition. 

Again, we cannot take more seriously the talk about the 
Avasted productive capacities of the parasitic classes. To start 
with, their number is absurdly exaggerated. A large proportion 
of the persons so designated are performing functions which are 
essential to high productive efficiency. In the second place, the 
difference which would be made by their productive efforts, if 
they were to become real producers in the popular sense, would 
be scarcely appreciable, — adding to the annual income of each 
person in a population of 100 millions, perhaps twentyfive or 
thirty dollars. 

Finally, in respect to the third objection of the socialist, he 
seems to economists to be seriously in error. As at not a few 
other points, he has made a mountain out of a molehill. There 
is no doubt the possibility of a contradiction between utility and 
value. That is, one who is seeking only to increase values may 
find himself in a position where he would better diminish output 
and so dirninish utilities ; and, since the immediate return to pro- 
ducers is a value return rather than a utility one, viz., purchasing 
power in the form of money, it naturally follows that producers 
will find themselves in a position where they can gain most by 
reducing, or at least checking the increase of, utilities. But, 
now, it is surely evident that the adoption and pursuit of such a 
poHcy as that indicated is possible only through concert of action 
among producers; since values can be increased by limiting out- 
put, only provided it is the total output which is thus limited, not 
merely that of some producers. But concert of action among 
producers is in contradiction to the very essence of the present 
order of which untrammeled private initiative is the dominant 
feature. Accordingly, it is quite illegitimate to represent this 
order as one in which it is inevitable that producers should seek 
to increase values to the neglect, or even the destruction, of 

330 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

utilities. Increase of values is doubtless the natural goal of the 
producer as producer; but, under a regime of free competition, 
the only path by which that goat can be attained is the increase 
of utilities. 

We have seen that the present regime is eminently adapted 
to insure that products shall be abundant and good. We have 
still to remark on the fitness of the present system so to guide 
production that products will correspond to wants, need. In 
one sense of these words all would at once admit that this requi- 
site is surely realized in the present order. Free private initiative 
combined with a free market, if capable of nothing else, is surely 
capable of adjusting output to wants. "But just here," the ob- 
jector will say, "we strike a serious ambiguity. The adjustment 
to wants, which takes place in the present order, is an adjust- 
ment to economic demand, which may or may not correspond 
to real social wants. In the case of the wants of the man who 
has money and can, therefore, contribute to economic demand, 
the present order will insure a production which provides for 
those wants ; but how about the wants of the man who is with- 
out the buying power? These wants are surely far more real 
and serious than the wants of the rich man. But, obviously, 
no one can contend that the present order insures that produc- 
tion shall be so guided as to provide for these wants." 

Now, the above represents an objection to the present order 
of much significance. But it is really an objection to the work- 
ing of that order on distribution rather than on production. If 
price is to serve at all as a regulator of production, the money 
incomes of individuals will necessarily be unequal, since those 
incomes are made up of the prices of contributions which those 
individuals are in a position to make, and said prices are bound 
to be unequal. But if money incomes are unequal, the power 
to demand goods, economically speaking, and so the power to 
consume goods will be unequally distributed. But, again, the 
needs to which production ought to be adjusted are surely the 
needs of those who will actually consume, — any other interpre- 
tation would be nonsense. It follows, then, that the objection 
brought out above is really an objection to the present system 
in respect to the distribution, rather than the production, which 
it effects- 

331 



PRINCIPLES OF ECONOMICS 

Section B. The Present Order and Consumption. 

As respects the regulation of consumption, a satisfactory 
system needs to show three results chiefly: (1) Those natural 
resources which belong to society as a whole and to posterity 
must not be sacrificed to the selfish greed of the individual and 
the present; (2) The satisfaction of immediate wants must not 
absorb all our producing efforts to the neglect of that building 
of capital on which great productive efficiency depends; and (3) 
The best utilization of a stock of consumption products already 
existing should be assured. 

With respect to the first of these demands, we must admit 
at once that it is very imperfectly provided for in the present 
order. Under the free working of private initiative, the vast 
resources of a continent in lumber, coal, iron, etc., are being 
rapidly dissipated, and that in too large measure for the benefit 
of very small classes. Even the race itself has been threatened 
with serious deterioration through an unbridled use of liberty 
in respect to the employment of women and children ; so that 
ever3'where governmental interference has proved a necessity. 
All this is natural enough. When we are dealing with the 
interests of the remoter future, it is only within quite narrow 
limits that we can trust the forces which ordinarily prove effi- 
cient and safe regulators of economic action (see Walker). 
The safeguarding of those interests is a duty which from its 
very nature rests upon the group, rather than the individual, 
Unfortunately, the group too rarely rises above the standpoint 
of those individuals who are economically most powerful and 
greedy ; so that the duty of the group at this point is too 
frequently neglected. Still it cannot be doubted that our only 
hope lies in this direction. Government must put great and rigid 
limitations on private initiative at this point, if the social patri- 
mony is to be saved at all. 

As regards the second requisite of a system which properly 
regulates consumption — that it should not permit the satisfaction 
of immediate wants to absorb all our productive efforts to the 
neglect of capital-building — our present system can give an 
excellent account if itself, — a better account, probably, than 
could be given by any system depending on public initiative. 
Capital increases at an amazing pace. This is doubtless not a 

332 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

little due to a feature of the system which is, in many respects, 
undesirable, viz., the extreme inequality of incomes, which, con- 
centrating so much in the hands of a few, makes the task of 
saving relatively easy. But this is not the only explanation. 
The present system powerfully stimulates accumulation in that 
it offers to those who save great rewards, not so much in the 
shape of interest, as in the shape of those profits which may be 
obtained by the skillful use of a small initial sum. A further 
reason is found in the fact that the present system supplies 
highly convenient and efficient machinery for assisting the pro- 
cess of capital-building, in the shape of savings banks, insurance 
companies, bond exchanges, etc. 

As regards the third requisite, — the best utilization of an 
already existing stock of consumption products, — the present 
system easily meets the case. It belongs to the very nature of 
the laws of exphange to establish a price which adjusts demand 
to stock, — reducing demand, if stock is scanty, by raising price, 
and increasing demand, if stock is excessive, by lowering price. 
But here, again, we meet the objection wkich was advanced 
when we were discussing the fitness of the present system to 
adjust production to demand. "Demand," it is said, "is adjusted 
to stock by being cut down through higher price ; but this 
means that the demand of the poor falls off, while that of the 
rich keeps at its old level." Now there is, no doubt, some truth 
in this; still it must not be taken too seriously. In the first 
place, the statement is much exaggerated. Save with respect 
to a very few commodities, indeed, the number of families who 
do not reduce consumption at all when price rises is very small, 
— so small that its continuance of the old scale cannot materially 
alter the result. Secondly, as before explained, we have here 
an objection which is really directed against the distribution 
side of the present order, and so is not germane to our present 
discussion. If value, price, is to play a directive role in the 
economic order, incomes are bound to be unequal. But if in- 
comes are to be unequal, then the relative importance which we 
impute to wants must correspond more or less fully with this 
inequality ; i. e., a certain want felt by a person of large income 
must be recognized as more important than the same want ex- 
perienced by a person of smaller income. This sounds brutal, 
but it is an unavoidable conclusion from the premises, as was 

333 



PRINCIPLES OF ECONOMICS 

brought out in the closing paragraph of the preceding section. 
As it is "a hard saying" and yet of much significance in con- 
nection with our present task, it will be touched upon again in 
the next section. 

Section C. The Legitimacy of the Distributive Principle 
Supposed to be Embodied in the Present Order. 

In this section we begin the study of one of the most import- 
ant question to which the economist addresses himself: Does 
the present order work out a reasonably satisfactory result in 
respect to distribution? In undertaking to answer this question 
with a qualified affirmative, as we do in the remaining sections 
of this chapter, we would again disclaim any purpose to contend 
that the present system of distribution even tends to be ideally 
perfect, much less that it actually is. We freely admit that the 
principle which it tries to realize is far below the best conceiv- 
able ideal, that our present order tries to carry out this principle 
while maintaining institutions which inevitably increase the 
evils which would in any case follow the application of the 
principle, and finally that in manifold respects the results are 
far worse than they need to be even under the full operation of 
the principle and its accompanying institutions, i. e., great im- 
provements are needed, are possible, and ought to be effected. 
Nevertheless, we hold that a verdict for the substantial sound- 
ness of the present order, even in respect to the distribution it 
effects, is inevitable. 

Our first task must be to consider the general principle of 
distribution which is supposed to be embodied in the existing 
order and ask ourselves whether, in general, that principle is a 
reasonable one, — whether, assuming the accompanying condi- 
tions satisfactory, that principle would commend itself as, on 
the whole, wise and just. In the discussion following, this ques- 
tion receives an affirmative answer. Let it be remembered, how- 
ever, that in giving this answer we do not mean to affirm the 
reasonableness and justice of the principle in question as it is 
actually worked out in the present economic order. In that 
order, land and capital are objects of private ownership, and so 
their product is credited to certain individuals. Obviously, if 
land and capital were owned by the state, although the present 
principle of distribution continued to be dominant, the results 

334 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

would be very different as far as the individuals in question are 
concerned. Again, the present order provides for an almost 
untrammeled right of inheritance. Eliminating this condition, 
although the dominant principle was left unchanged, would 
surely cause a great change in the results. 

1. What is the Supposed Distributive Principle of the Present 

Order? 

It might, perhaps, be presumed that the answer to this ques- 
tion has been given sufficiently often, by implication at least, to 
make its repetition in this connection unnecessary. In order, 
however, to avoid possible misunderstanding we shall set forth 
the principle once more. Under the present order, when compe- 
tition is free it is believed that each gets approximately that 
income which expresses the marginal signiUcance of the natural 
supply of the type of contrihuthn made by himself or his prop- 
erty to the sum of utilities, and which at the same time expresses 
approximately the marginal disutility, original or derived, in- 
volved in making said contribution. 

2. Some Other Possible Principles of Distribution. 

It is scarcely necessary to say that no adequate critique of 
the dominant principle of distribution can be effected without 
some contrasting of that principle with possible substitutes. 
Of these the number is legion; but only two or three have had 
serious following. 

A. Doubtless the most ideal principle of distribution is that 
which we try to realize in some degree in the family life, as 
also in the life of the state in the periods of greatest social 
exaltation. I mean the principle that each shall receive of the 
common income in proportion to his need, — having given in 
proportion to his capacity. This seems to have been, and to 
be still, the formula of the highest type of communism. "From 
each according to his capacity; to each according to his need." 
To the present writer there seems no room for argument as to 
the ethical superiority of this distributive ideal over all others. 
If human nature were equal to the maintenance of such an 
ideal, no other formula would deserve a moment's consideration. 
But surely no one will seriously urge this as a possibility for 
the ninety millions of men, women, and children who constitute 
the population of the United States. Even those few hundreds 

335 



PRINCIPLES OF ECONOMICS 

who succeed in living somewhere near such an ideal in Amana 
and other communistic associations admit that their very lim- 
ited success is made possible only because of certain very in- 
tense religious sentiments which are common to all the members 
and which it would never be possible to find in more than a 
very small minority of the population. 

B. Next to the need ideal of distribution comes that of 
equality. To each an equal share, but from all service, is its 
motto. This is the more usual communistic ideal. It is ap- 
parently favored by many socialists. There is no doubt much 
to be said for it. The greatest discomfort from poverty is 
probably due to the contrast with the position of more favored 
neighbors. As a matter of mere sentiment, I sympathize with 
those persons who declare themselves willing to pay the price — 
the inevitable price — of equality, i. e., an equality of misery. 
But after all it is quite out of the question. Equality in income 
would sacrifice the real, material welfare of all classes to mere 
sentimental considerations. Further, it would not even embody 
the ethical ideals which dominate practically the whole com- 
munity. For however people may feel toward interest, rent, 
and profits, they almost universally believe that wages and 
salaries, anyhow, ought to bear some relation to service rendered. 

But this is too important a matter to be so lightly disposed 
of. Are we right in saying that an attempt to enforce complete 
equality would sacrifice the real material welfare of all classes 
to mere sentimental considerations? In support of this view, 
there are perhaps three chief considerations: (1) In the first 
place, there are not a few cases in which giving some persons 
larger incomes than the rest of us may properly be described 
as directly required in the interests of the rest of us, in that 
the larger income is necessary to enable said persons to per- 
form efficiently the important tasks we have assigned them. 
Thus we can be sure that no sensible person would contend 
that the people of the United States could afford to have their 
chief executive live on $1,000 a year even if he were perfectly 
willing to do- so. To do his job at all well, he must spend, on 
matters more or less personal in their nature, many times $1,000. 
What is true of the president of a great republic is true in 
only lesser degree of hundreds of other men. In fact, if we 
sufficiently narrow the circle of interested persons, it is true in 

336 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

a way for almost every male citizen. To the other members 
of his family, it is more important that the breadwinner, though 
the humblest of day-laborers, should be well fed than that the 
rest should be, because only so can he be fit to earn the income 
on which they all depend. But, of course, the point is more 
forcefully illustrated in the greater relations of society. To 
those men whose functions involve large responsibilities, 
intense mental activity, and great nerve strain, we must 
for our own sakes, give large incomes in order that they may 
prove resolute, clearsighted, well-poised, and in other respects 
fitted for their great tasks. To this, however, the objector may 
say that we really have here a case not of better income, but 
rather of collateral expenses. Needs such as these should be 
provided for as part of the outlay of the oiflce which the man 
holds. If $1,000 is the best income the community can afford 
its members, the president, as a man, must be satisfied with that 
income ; though on his office we may spend $100,000. Doubtless 
something, perhaps much, could be done along this line ;* 
but the whole difficulty could not be met in this way. The need 
involved is often so personal, individual, in character that it can- 
not be provided for save through a fund placed at the disposal 
of the person interested. One person requires one sort of re- 
laxation, perhaps a very inexpensive one; another requires a 
very different sort, perhaps a very costly one. Further, the 
employing public (under socialism), with whom opinion is 
greatly under the influence of persons who are not in a posi- 
tion to judge of the personal needs attaching to the higher 
social functions, would commonly underrate those needs, as is 
shown in the niggardly salaries now paid public officials in 
democracies. In consequence, provision for this kind of need, 
if made in a formal sort of way, would probably be far too 
small. 

(2) The preceding paragraph has brought out one reason 
why inequality of income is necessary in the interest of the very 
persons whose apparent incomes would be raised by the abolition 
of that inequality. A second and more important reason, which in a 
way belongs to the same class, is found in the fact that unless 
incomes are unequal, they will not even approximately express 



^Personally I heartily believe in such a policy wherever possible. 

337 



PRINCIPLES OF ECONOMICS 

the relative sacrifices involved in contributing different services, 
and, so, will cause an oversupply of services which involve small 
sacrifices and an undersupply of the opposite kinds. This diffi- 
culty has always been recognized by the creators of Utopias ; and 
to meet it a considerable variety of ingenious schemes have been 
brought forward. Thus, some writers have proposed that con- 
scripts from all classes should have to serve a certain length 
of time in objectionable trades. Others have reserved these 
occupations for the convicts. More recently, we have had much 
stress laid on (a) variations in the length of the labor day and 
(b) honor rewards. An undesirable occupation might be made 
attractive by reducing the day from 6 hours to 4, or 3, or any 
figure which might prove necessary. So, attractiveness might 
be given said occupation by attaching thereto decorations, official 
rank, and so on. Now, it seems highly improbable that these 
devices should have anything like the effectiveness which is 
anticipated from them. The honor device, especially, overlooks 
the fact that honors, to be effective as a stimulus to emulation, 
must not be too commonly employed. Gaining a prize is not 
worth while, if almost all the contestants gain prizes. Being a 
member of an academy which every one can join by paying $5, 
will attract people only so long as they are ignorant of the 
facts. But, whether these schemes are practicable or not, there 
can be no doubt that they are inconsistent with real equality. 
Why do I object to my neighbor's having a better income than 
I, supposing mine to be enough for a decent life? Obviously, 
it is because the spectacle of his enjoying advantages which 
I can not enjoy detracts from my peace of mind. Now, what 
matter as to the source of these advantages ! To see him 
watching the great national game, or comfortably lying in the 
shade, while I toil and sweat in the sun would surely awake 
in me an unpleasant sense of contrast if these privileges were 
granted him as a direct reward for accepting some particular 
task just as truly as they now give me such an experience when 
they come as an indirect reward for that same service. So, 
again, one of the greatest objections to the inequality of the 
present order is that it gives to the men of larger incomes a 
higher place in the consideration of their fellows, better social 
standing, and so on. Will this deeper sort of inequality be 

338 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

any less obnoxious when it is directly created than when, as 
at present, it is the indirect result of inequality in money income? 

(3 We have brought out two reasons why people generally, 
considered as consumers, must in their own interest prefer 
that there should be inequality of incomes, — that some other 
persons should receive better incomes than themselves. We 
have reserved for the last the weightiest reason of all. There 
must be inequality of incomes, some contributions must com- 
mand much higher prices than other contributions, because only 
in this zvay can it be made certain that society will make the 
best use of its resources, its productive capacities. In a previous 
discussion. Section G, Chapter IX, it was shown that, in a 
world like ours in which different kinds of ultimate factors 
enter in different proportions into the production of different 
commodities, said different kinds of ultimate factors being lim- 
ited in amount and capacity, eacli of said kinds of factors will 
have its own special significance or importance as determined 
by the part it plays in producing goods. In the same connec- 
tion, it was also explained that, under the present system of 
free private initiative and exchange, the assigning to each factor 
a price which expresses approximately its true significance is 
accomplished automatically. Now, we hardly need say that by 
some process or other tlie same task must be performed under 
any system of economic organisation, e. g., socialism; since, 
otherwise, we could not have any assurance that we were making 
the best use of our capacities. 

In the first place, assigning to things their proper price 
would be necessary under socialism just as truly as at present, 
as a part of the public system of bookkeeping. For it is hardly 
necessary to say that, if the state were to become the sole 
landlord, capitalist, and entrepreneur, it would be obliged to 
carry on an elaborate and complete system of bookkeeping in 
order to have at hand the knowledge of conditions necessary to 
a reasonable conduct of economic affairs ; and, in this book- 
keeping, the state would need to credit each ultimate factor 
with the true significance of that factor, since, otherwise, it 
would frequently waste important factors on unimportant com- 
modities. That is, whether or not men were actually to receive 
unequal incomes, they would have to be credited with unequal 
contributions. 

339 



PRINCIPLES OF ECONOMICS 

But, it having been admitted that the books of the socialist 
state would be obliged to credit each person with the true 
value of his contribution, can it be doubted that, under any 
system which is in the remotest degree practicable, said value, 
or something approximating it, would have to be paid to the 
man who made said contribution? We say "under any system 
which is in the remotest degree practicable ;" for one miguL admit 
that a despotically organized communism, a system under which 
the effecting and regulating of cooperation is through authority, 
could "exploit the workers" — to use a socialist phrase, — i. e., 
could give equal remuneration for very unequal services. But 
surely we do not need to take communism seriously. We need, 
therefore, to consider only the case of socialism. Could that 
system of economic organization escape paying men in some 
proportion to their contribution? The answer is surely a nega- 
tive one. One could, indeed, conceive a socialist state which at 
first thought would seem able to avoid the necessity of adjusting 
reward to contribution; — I mean a state conterminous with the 
earth and organized as a completely centralized despotism. Such 
a state might seem to be emancipated from all necessity for 
paying its workers according to any standard other than its 
own sweet will; since competition would have been completely 
eliminated. But, while the hypothesis is too fantastic to merit 
serious consideration, I doubt if even the vast despotism sup- 
posed would be able to exploit the capable in any such way, — 
and that for two reasons: (1) the capable would probably be 
in power, (2) if not, they would anyhow know their importance 
and by a simple refusal to work for less could compel the 
authorities to raise their pay till it equaled the value of their 
contribution. 

But it is surely quite unnecessary to take seriously the idea 
of a cooperative commonwealth coextensive with the earth and 
organized as a completely centralized despotism. If we ever 
have a collectivist state, it will be one among many sovereign 
states and a state in which local autonomy, municipal and pro- 
vincial, still exists. It will, therefore, be one in which competi- 
tion still exists. Different municipalities, different common- 
wealths, different sovereign states will more or less vie with 
each other in trying to attain the highest efficiency, and so will 
drive one another into paying laborers what they are worth. 

340 



CHAPTER XIIL CRITIQUE OF PRESENT ORDER. 

As a general result of this long discussion, I think we may 
conclude that the ideal of distribution which would give to 
each citizen an equal share with every other is entirely out of 
the question : — the remuneration received by each must bear 
some sort of relation to his contribution. But, in insisting upon 
this point, we would not be understood as claiming that inequal- 
ities must always be just as great as they are today. We have 
no doubt that they would be much reduced under a socialist 
regime and that they will be much reduced under the present 
regime. Our present task is merely to make it clear that 
inequality is inevitable.* 

C. We have discussed the Need and Equality ideals of 
distribution. We ought perhaps to touch briefly another ideal 
which seems to have been more or less consciously held by 
many socialists of the earlier type. Each should share in the 
joint income in proportion to his labor. This of course can be 
dififerenth' interpreted. One may have in mind the sacrifice made 
or the results accomplished. He may conceive the sacrifice as 
measured in a subjective standard or an objective one like time. 
In general, the socialists seem to have had in mind primarily 
the sacrifice ideal, measured by the time spent. Yet they tried 
not to divorce this completely from results, by insisting that 
the labor in question must be labor which produced things, and 
standardised labor at that, — i. e., labor which in the given place 
and time was "socially necessary" to accomplish the result. 
Marx made a further concession to reality by admitting that 
we could not treat all kinds of labor as quite the same, though 
he would not admit qualitative differences. The labor of the 
artist and that of the mechanic must be treated as differing in 
intensity, or density, so to speak. That is, one hour of the 
artist's labor should be reckoned as the equivalent of, say, 
three of the mechanic's. The futility of all this is easily shown. 
Any scheme of distribution which can reasonably ask for our 
verdict must in serious measure make economic reward condi- 
tioned upon economic significance, — differences of economic 
reward correlative to differences in economic significance. This 
Marx tacitly admits by refusing to reward labor which produces 



*If the object were of sufficient importance one might easily show 
that inequality has considerable compensations. 

341 



PRINCIPLES OF ECONOMICS 

nothing, useful, and by insisting that all labor must be stand- 
ardized, reduced to "socially necessary labor." But differences 
in the economic significance of the several kinds of labor often 
show no correspondence either to labor time or to labor intensity. 
Accordingly, it is quite out of the question that labor as meas- 
ured in labor time, even when corrected for intensity, should be 
accepted as the principle of distribution. 

D. There is one other conceivable ideal of distribution which 
is probably more or less definitely held by many intelligent 
people, let us call it the Social Service ideal. This ideal differs 
from that embodied in the present order in that, under the 
latter, each is paid the price which expresses the significance 
of his services to individuals graded according to the buying 
power they possess, while, under the social-service principle, 
the significance of a man's services to the group as a whole or 
to all individuals without any reference to their wealth or 
poverty, would be the criterion. 

This ideal of distribution has no doubt a very plausible 
sound. There is something particularly obnoxious in the fact 
that, under the present system, the power to furnish services 
of a very trivial sort, or even services highly immoral in their 
character, enables the owner to command a large income, be- 
cause persons desiring such services chance to possess great 
buying power. But, after all, there is nothing in this proposal. 
First, in so far as it concerns the group as a whole, the new 
principle is already contained in the old. The group is fully 
organized and through the use of the sovereign power of taxa- 
tion can insure that group wants are satisfied at whatever 
cost, i. e., can see that services to the group are paid for in 
accord with their importance. Secondly, the proposed ideal as 
applied to individuals, is self-contradictory: — a principle of 
distribution simply can not pay according to the importance of 
the service rendered and not pay according to the importance 
of the service to individuals graded according to buying power. 
(1) Since men are to be paid in accord with services rendered, 
they are to be paid unequally. (2) This obviously means that 
the effective demand for commodities and services will be un-- 
equally distributed. (3) But the distribution of effective de- 
mand will necessarily determine in what proportion people will 
actually consume goods. (4) But the only importance which 

343 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

can signify anything is importance to actual consumers. (5) 
It follows, therefore, that to pay for services according to their 
importance to individuals without discrimination as to wealth 
or poverty, is to pay for those services in accord with their 
importance to persons who do not get them at all, — a process 
which really amounts to paying for services zvithout regard to 
their iviportance. 

3. Argument for the Service-Value Principle. 

That the service-value principle is entirely defensible, in fact 
is the only defensible one, has almost necessarily been estab- 
lished in arguing for the impossibility of the equality ideal. 
But it is perhaps best to give a formal summary of the case 
and comment on two or three objections. 

A. The ultimate and unassailable justification for the 
Service-Value Principle is necessity. Under no other principle 
could the economic action of a society in which any degree of 
individual liberty or local self-government was retained, be 
rightly guided, — i. e., guided so as to make the best use of its 
capacities. Theoretically, perhaps, a despotic state, world-wide 
in extent and completely centralized in administration, could 
come somewhere near the result by much experimentation, at 
the cost obviously of a ruthless exploitation of the capable in 
the interest of their fellows and of society in general. Even 
in that case, however, it would be necessary to credit each 
agent in production with the whole value of his contribution. 
For value, price, is nothing more than a particular method of 
expressing the relative importance of things. Correct prices, 
therefore, are necessary if we are to be furnished with correct 
estim.ates of this relative importance. But, further, in the case 
of elements the output of which depends on human consent, it 
is not enough that we have correct paper prices, — bookkeeping 
prices, — we must also have correct real, objective, prices, i. e., 
we must pay correct prices ; for, only in that way, can we insure 
the forthcoming of the several elements in their proper propor- 
tion. If socialism ever triumphs, if the state comes to under- 
take the responsibility of production as the sole entrepreneur, 
it will find itfeelf obliged to pay its employees in a general 
accord with the true values of their contributions. It might 
still effect a vast improvement in the lot of the majority of 

343 



PRINCIPLES OF ECONOMICS 

men by eliminating many violations of the service-value prin- 
ciple which corrupt the present order, by exploiting in the 
interest of all rather than of the few the great natural resources, 
by abolishing or very strictly curtailing inheritance, even by 
taxing with considerable severity the incomes of those who 
supply specially valuable services. But, after all, the socialist 
state would find itself obliged to adopt as its guiding principle 
the same old rule that the values imputed to things must be 
a true expression of their marginal significance, and that the 
prices of those particular things which, being bought on the 
open market, have prices must correctly express their true 
values. 

B. The preceding paragraph has brought out the positive 
argument on which is based a final verdict in favor of the 
Service- Value principle. Let us take a moment to comment on 
one or two objections. 

(a) Probably the misgiving which most persistently recurs 
to a fair-minded man who in general recognizes the full weight 
of the argument for the service-value principle, is that the 
whole attitude of mind in which such a principle seems plaus- 
ible to us is somehow too ccld-hlooded, too insensible to consid- 
erations of sympathy, humanity, love of one's fellows. When 
one is exercising his logical faculties on mere abstractions or 
is dealing with concrete objects which are mere things, e. g., 
apples, potatoes, etc., it sounds all right ; but the case is very 
different when the interests at stake are the incomes and, 
therefore, the happiness of living human beings. Is there not 
something inherently shocking to our moral sense, even to our 
sense of mere decency, in the advocacy or adoption of a prin- 
ciple which places interests like these at the mercy of so unmoral 
a thing as the law of supply and demand, or the law of marginal 
utility? Does not every right-minded man, at one time or 
another, respond with full approval to the belief expressed by 
Mill that a time would come when the division of society's 
product, instead of being a matter of automatic, mechanical, 
regulation, "would he made by concert on an acknowledged 
principle of justice" f In fact, is not this whole attitude of 
mind which conceives human beings as functioning, i. e., as 
mere instruments, mere things, inherently wrong? Must we not 

344 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

rather at all times conceive human beings as ends in themselves, 
never mere things? 

Now there is surely some force in all this. We have never 
denied that a higher principle of distribution than the present 
one is possible. We merely insist that this is the only practicable 
one. We believe that its working in the actual order can be 
greatly improved by changes which would better satisfy the 
demands of moral and humanitarian sentiment above alluded to. 
We believe that its worst tendencies could be, and are, not a 
little offset by a secondary distribution through voluntary benev- 
olence and the use of the taxing power,— all this in obedience 
to the same moral and humanitarian sentiment. But, when all 
is said and done, we have still no choice but to submit our- 
selves to a necessity which, if somewhat shocking to sentiment, 
is after all very real. We must accept the domination of the 
service-value principle, because it is the only principle which 
can sustain society from falling into the poverty and misery 
of communism. Nor, in truth, is the domination of the 
service-value principle quite the dreadful thing it is pictured. 
The correctness of the humanitarian sentiment above expressed 
is not quite so certain as is often assumed. Not a few people 
persist in believing that a man ought to be paid what he is 
worth. A still larger number feel no response to the notion 
that it is wrong ever to conceive human beings as functioning, 
as in some relations mere instruments, mere things. There is 
nothing unworthy or degrading in taking one's turn at being 
a mere thing, a something which functions in the service of 
others. On the contrary, most men who have passed forty have 
come to feel that there is little else that is worthy or satisfy- 
ing; and they have on their side the opinion of the greatest 
religious teachers. In any case, whether it is a burden or a 
privilege, a curse or a blessing, it is the destiny of all. From 
the highest to the lowest, we must spend a considerable part 
of our lives being the servants of others, mere instruments to 
secure their welfare. 

(b) Among people who interest themselves in our problem 
but have little or no economic training, there appears some 
disposition to criticise the ruling principle of distribution be- 
cause it pays men in accord with what we might call their 
effective utility rather than in accord with their absolute utility 

345 



PRINCIPLES OF ECONOMICS 

Thus, the utility of coal miners as a class is surely far greater 
than that of high-grade singers as a class ; but society pays 
a miner for an hour's work, perhaps, 40 cents, while it pays 
the singer for an hour's work, perhaps, $2,000. This objection 
always arouses a sympathetic response in the popular mind; 
but to the student who has acquired any comprehension of 
economic relations, it is quite without point. A person who 
puts forward this objection really admits by implication that it 
is right to have men paid in accord with the importance of their 
serznces; the objector only complains that we set the wrong 
standard for judging importance. The answer is easy. The real 
importance of any man is his effective importance, — what we 
should lose if we lost him, not what we should lose if we lost 
his whole class. For in nearly all cases, the alternative facing 
Us is, not keeping or- losing the whole class, but keeping or 
losing an individual of the class ; and what we lose by losing 
any individual of a class is only the utility of the least useful 
of the class, since the loss of any higher utility would be avoided 
by transferring the least important member of the class from 
his present task to the higher one. 

(c) Another objection closely allied to the last criticises 
the Service- Value principle because it pays a man, not in accord 
with his own specific utility, but in accord with the utility of the 
marginal member of his class. Thus, a man may be performing 
some service for which his employer is glad to pay him, and 
does pay him, $2 a day ; when, without any fault on the work- 
man's part, an increased supply of labor comes, on the market 
and lowers the marginal utility of this class of workmen to 
$1.50 per day, with the final result that the first workman, 
though still performing the $2 service, now gets only $1.50. 
This objection makes less appeal to one's sympathies than the 
preceding one ; since it could easily be contended that to pay 
one man $2 a day, when another working just as hard and 
perfectly able to replace the first was getting only $1.50, was 
doing wrong to the latter. But, whatever the merits of the 
sentimental issues involved, this objection, like its predecessor, 
is quite untenable logically. If a man is to be paid in accord 
with his importance at all, the importance in question must be 
real, effective importance. But the real importance of a man 

346 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

is determined, not by the importance of the particular thing he 
accomplishes, but by the importance of the thing which the 
marginal member of his class accomplishes. 

Section D, The Legitimacy of Interest, Profits, and Rent, 
Supposing Them to be Absorbed by the State. 

In the preceding section we have contended for the legiti- 
macy of the present system in respect to the general principle 
of distribution which it is supposed to embody : — Give to each 
person an income which expresses the marginal significance to 
his fellows of his type of service. But, as has been repeatedly 
pointed out, this leaves much of our task unaccomplished. The 
Service-Value principle may be all right in general but quite 
wrong when applied under the conditions prevailing in the 
present order. Thus, in the present order private persons are 
permitted to own land and capital, and, so, the services of 
land and capital are reckoned as the services of said private 
persons, with the final result that, under the working of the 
service-value principle, said private persons receive interest, 
profits, and rent. Is the service-value principle, when so applied, 
legitimate? In other words: Are interest, profits, and rent, 
as sources of private income, legitimate? In answering this 
question, we begin with a preliminary question : Are interest, 
profits, and rent legitimate, supposing them to be absorbed by 
the state? To this we will devote the present section. 

1. The Legitimacy of Interest, Supposing the State to be the 

Sole Capitalist. 
In an earlier connection, we discussed the various manifesta- 
tions of the interest phenomenon which are found in the exist- 
ing order. Of these manifestations, we found two general 
classes : explicit and implicit interest. Under thoroughgoing 
socialism, explicit interest — interest on contractual loans — could 
exist, if at all, only on the smallest scale; since, with the state 
occupying the position of sole entrepreneur as well as that of 
sole capitalist, productive borrowing would be excluded, while, 
on the other hand, consumptive borrowing from the state would 
be consciously restricted within very narrow limits. Accord- 
ingly, interest, if appearing on any considerable scale in the 
thoroughly socialist state, would be of the implicit type; that is, 
it would show in the prices of goods, — meaning both the prices 

347 



PRINCIPLES OF ECONOMICS 

quoted on the market in the case of goods which were sold 
to private persons, and the prices recorded on the books of the 
g-overnment in all cases. We will begin with the second case, 
i e., the prices recorded on the government's books. 

As has already been pointed out and as must be evident 
to every one, if government is to perform the stupendous task 
of conducting all industrial activity with any sort of success, 
it must keep a complete, detailed, and trustworthy set of 
accounts — a set of accounts which represents the true values of 
both immediate and ultimate goods; — since, without such ac- 
counts, said government could never be sure that it was con- 
ducting its vast interests in such a way as to make the best 
use of the resources at its command. In short, the government 
of a socialist state will need just as elaborate and complete 
a system of values, prices, as that existing today. But, while 
a complete system of values will be necessary, it is of course 
possible that the values will in many cases be somewhat different 
from those of an individualist regime. Nay more, it is possible 
that some cases of value may disappear altogether. A thing 
or a condition comes to have value only when two conditions 
at least are fulfilled: (1) its disposal must involve some advan- 
tage, and (2) there must be some limitation on its being sup- 
plied, whether absolute or conditional (cost). Now it is conceiv- 
able that, under socialism, one or the other of these conditions 
will be lacking in cases where both are present under the exist- 
ing regime. Thus, the advantage derived from a service today 
may be of such a nature that it will disappear when socialism 
is established, e. g., the services of an office furnishing abstracts 
of titles. On the other hand, the effective limitation of supply 
now existing may be due to the arbitrary action of a monopolist 
and so bound to disappear under socialism. Are either of these 
possible in the case of interest? Would the advantage or advan- 
tages for which interest is paid disappear under socialism? 
Would the supply of the condition which furnishes that advan- 
tage prove so abundant that it would no longer have marginal 
utility and therefore no longer have value? A negative answer 
is inevitable in both cases. 

First, the advantage or advantages for which interest is paid 
would not disappear under socialism. As was brought out in 

348 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

Section G, Chapter XII, the essential nature of the transaction 
through which interest arises is the exchanging of future for 
present goods. That is, interest is usually a price paid for the 
privilege of having goods now, though we do not pay for them 
till later. Now, this privilege carries with it different advantages 
under different circumstances. Of these, the greatest and most 
important is commonly expressed by saying that capital is 
productive. By getting control of a fund of wealth new while 
freed from the necessity of paying for it till later, we are 
enabled to choose the more efficient methods of production 
which require longer periods of time. A lesser advantage flowing 
from the privilege of exchanging future for present goods is 
that it enables us to substitute payment at a more favorable, 
for payment at a less favorable, time. Thus, a man starting in 
on a job has perhaps no surplus in his purse; a month later 
he will have seventy-five dollars ; the exchange which enables 
him to bring into the present the better provision of the 
future has surely given him an advantage. Now, would these 
advantages continue to exist under socialism? Surely yes. It 
may be that the second advantage will cease to be effectual 
because the socialist state refuses to make advances to imprudent 
or unfortunate citizens who wish to anticipate the provision of 
the future ; but the need will certainly exist and so the possible 
advantage. As respects the supreme advantage derived from 
the possession of capital, — being able to choose more efficient 
methods of production — this certainly could not disappear save 
on the hypothesis that the whole order of physical relations was 
overturned and a new one established in which direct, immediate, 
methods were more efficient than roundabout, time-consuming, 
methods. Of course no one anticipates any such revolution in the 
natural order of the physical universe, as a result of the 
establishment of socialism. Under that system, it would still 
be necessary to make tools before we made tables. The power 
to wait, the being so situated that we could devote wealth 
or productive power which might be employed for present needs 
to providing for future needs, — this would be just as necessary 
under socialism as under the present order. It is certain, then, 
that the privilege of exchanging future against present wealth 
would be of advantage to the governmental entrepreneur of the 

349 



PRINCIPLKS OF ECONOMICS 

socialist system just as it is to the individualist entrepreneur 
of our system. 

But, in the second place, is it at all likely that the other 
condition which is necessary to give presentness a value, viz., 
that it should be relatively scarce, will disappear under social- 
ism.? I^"" 'support nf an affirmative answer, some one misht say 
that the scarcity existing at present is artificial, and so would 
disappear when the only capitalist is the state, the sovereign. 
But this is manifestly unsound. There is scarcely any other 
part of the economic structure in which competition is so 
free as in the market for capital. An artificially controlled 
supply is quite out of the question. If the scarcity now existing 
is to disappear under socialism, this will have to be for some 
other reason. Can it be that capital will increase far more 
rapidly under socialism than it does at present? Surely the 
contrary is to be anticipated. The absence of excessively large 
incomes will cut off one great source of capital ; another will 
go with the removal of the necessity for saving on the part of 
the masses under a regime which assures every one a liveli- 
hood; finally, the direct turning back of income into business 
on which socialism must almost entirely rely, will be much 
more difficult when all authority is in the hands of a democracy, 
eager for the present and reckless of the future. 

It hardly seems necessary to carry this discussion further. 
We surely can not doubt that under socialism the right to 
dispose of present goods while paying for them in the future 
would have a marginal utility and would, therefore, have value. 
The socialist state would have to treat the future uses of a 
piece of land as worth less than its present use, and, so, would 
have to make the sum of these uses — the value of the land — 
a good deal less than one use multiplied by infinity. Again, 
the socialist state would have to treat goods which cost $200 
worth of past labor and $100 worth of current labor as more 
valuable than goods which cost $300 worth of current labor. 
And so, in every relation where implicit interest appears under 
the present regime, it would appear in the socialist bookkeeping. 

The preceding discussion has shown that implicit interest 
would have to appear all through the bookkeeping of the social- 
ist government. We have still to answer the question whether 

3o0 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

it would be present in the prices of goods sold on the market. 
For example, would the state find itself practically obliged to 
charge more for goods the production of which involved the 
use of large quantities of fixed capital than for goods " which 
were almost entirely produced by current labor. Doubtless 
another policy could be conceived. While keeping its books 
soundly, the state might decide to sell some goods below cost — 
cost being interpreted so as to include waiting, interest on 
capital. But it could not pursue such a policy without unequal 
and unjust treatment of its citizens. For there can be little 
doubt that in most cases there would appear great differences 
among citizens in respect to the amounts they would consume 
of these products which involve a large interest element. On 
the other hand, the burden of accumulating capital by turning 
the capacities of the community into the producing of future 
goods — goods dependent on time-consuming processes — would 
fall on people generally. The only way to insure fair play, 
then, would be to raise the prices of such products till those 
prices were high enough to put the burden of producing said 
products entirely on those persons who consumed them. Ac- 
cordingly, we conclude that interest in itself is a legitimate 
element in price, — that, supposing such interest to be absorbed 
by the state as the sole capitalist, it is an entirely legitimate 
share in distribution. 

2. The Legitimacy of Profits, Supposing the State to be the 

Sole Entrepreneur. 
Of all the regular economic incomes, profits would probably 
show greatest modification under a socialist regime. Yet even 
profits would doubtless appear in somewhat disguised form, and, 
hence, must be reckoned as a perfectly natural and legitimate 
source of income under the proper conditions. In support of 
this contention, little more need be said than to remind the 
reader of the points previously made with respect to this 
particular source of income. Profits, as popularly interpreted, 
commonly include three elements: wages, interest, and profits 
proper. The wages element would of course persist under 
socialism. So also would the interest constituent, as we have 
just seen. What, then, as to pure profits, — the excess over 
ordinary interest received by the entrepreneur who turns over 

351 



PRINCIPLES OF ECONOMK S 

managerial functions to others? That excess, we have argued, 
owes its origin to the burdens which are involved in taking the 
final responsibility of production. Of these burdens, the chief 
is the fear of loss, though, under the existing order, other 
psychological elements are doubtless present. Now, it seems 
quite certain that, under a socialist regime, this bnrdpn would 
be altered fundamentally in character, as also somewhat dimin- 
ished in amount ; but it would not be eliminated. At present 
the burden takes the form of a risk of never-to-be-compensated 
loss; and profits constitute the prize necessary to induce men 
to overcome their natural indisposition to assume such a risk. 
But, under a system which concentrated all resources in the 
hands of a single owner, all risks would be pooled, and, there- 
fore, would almost disappear as risks, being replaced by the 
certainty of fairly regular losses. In other words, the socialist 
state would be obliged every year to write off a considerable 
volume of losses.* That is, some of its expenditure would 
have gone for nought. To make its books balance, this excess 
of expenditure would have to be charged against all, or some 
portion, of the products which resulted wherever industry was 
successful. Naturally the products chosen would be those of 
the industries where the losses had occurred. In no other way 
could we avoid burdening other citizens in the exclusive interest 
of those who consumed the products of riskful industries. We 
conclude, accordingly, that profits constitute a legitimate, even 
necessary, element in an economic system, — being inevitable 
even in a socialist state. t 

3. The Legitimacy of Rent, Supposing the State to be the 

Sole Landlord. 
Here an extended discussion is even less called for than 
under Profits. Rent inevitably emerges as the result of any 
process of natural value determination. It could not help exist- 
ing under socialism. As soon as the best land, cultivated to the 
point of diminishing returns, proves unable to satisfy the 

*As also to credit itself with some unexpected gains. 

tin would be easy to argue that in many cases the burden of profits 
upon consumers would be greater in the socialist state than it is today, 
in that today private entrepreneurs gamble, so to speak, on the 
chance of loss or gain, whereas the socialist state would reduce the 
whole matter to a question of arithmetic, and, having ascertained the 
precise loss, would distribute it upon the product pro rata. 

352 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

demand for product at any price above cost of production, 
price rises and in so doing creates a surplus over cost v^hich 
under any regime is bound to be credited to the given piece 
of land. Being so credited, the land takes on value as the 
source of said surplus. If the surplus is large, the value is 
large. All this is inevitable under any rational system. The 
socialist state probably could not get rid of it by any action 
however arbitrary. This would apply, not merely to the book- 
keeping of the state, but also to the system of market prices. 
For surely the socialist state could not have different prices 
for the same product in the same time and place, and it could 
not fix as the one price anything under the marginal cost of 
production; since, in so doing, it would discriminate in favor 
of the consumers of the particular commodity in question as 
against the rest of its citizens. But, if the state leaves prices 
to be fixed at marginal cost, it thereby permits rent to exist. 

Section E. The General Legitimacy of Interest, Profits, and 
Rent as Sources of Private Income. 

In the preceding section, we argued for the legitimacy of 
interest, profits, and rent, supposing the state to be the sole 
capitalist, entrepreneur, and landlord. That is, we argued that 
these shares correspond each to some portion of the output, 
which portion, on any rational system of valuation, is to be 
imputed or credited to the productive factor involved. They 
would, therefore, exist, and ought to exist, if the present 
economic system were replaced by the cooperative common- 
wealth.— only in that case they would fall to the state and so 
would benefit all rather than the few. There still remains to be 
considered the question whether interest, profits, and rent are 
legitimate as private shares, — sources of private income. This 
question, however, really contains two questions: (1) Whether, 
abstractly speaking,— viewed broadly — the shares named are 
legitimate sources of private income, and (2) whether, under 
the conditions actually prevailing, with all the weaknesses of 
human nature, these shares are legitimate. It is the first of 
these questions which we here consider. 
1, The Legitimacy of Private Interest, Abstractly Considered. 

Those who affirm that there is something essentially wrong 
in permitting private persons to receive interest must maintain 

353 



ILLUSTRATIVE PROBLEMS. 

either (l) that it is essentially wrong to permit private persons 
to own capital, or (2) that, though right to permit private per- 
sons to own capital, it is essentially wrong to permit them to 
receive a net income from that capital. Now the first of these 
alternatives surely need not delay us long. As against com- 
munism, indeed, a defense of the right even to own capital 
without deriving any income therefrom, would be necessary; 
since communism holds that no right of property is legitimate. 
But today communists are almost unknown. It is only with 
socialists that we have to reckon; and socialists are constantly 
admitting both directly and indirectly that there is nothing 
inherently wrong in the private ownership of capital. Thus, 
they hold that it was right for private persons to own capital 
so long as the persons who did the owning were the laborers 
who used the capital for productive purposes. Further, they 
expect that under socialism individuals will be permitted to 
accumulate surpluses of general w^ealth, which today constitute 
the original form of all capital. Again, they constantly admit 
that, if the capitalist of today would be content to receive back 
what he puts into industry, relinquishing the surplus, no wrong 
would be involved. 

But, even if the socialist should affirm that the private own- 
ing of capital is inherently wrong, he would find few to agree 
with him. The case is too evident, according to his own funda- 
mental ethical principle. For the fundamental ethical principle 
of socialism is that each has a valid title to what he produces; 
and, though men doubtless become owners of capital through 
fraud, corrupt practices, gift, inheritance, and other methods 
which can not be described as producing said capital, yet it is 
equally certain that they may become, and do become, owners 
of capital by producing it; so that, on the very principles of 
socialism, they have a right to own said capital. 

We come then to the second of the only two alternatives 
which are open to the man who affirms that the taking of 
interest by private persons is essentially wrong; — it is essentially 
wrong to permit the owners of capital to receive a net income 
from that capital. Now, this position, again, is quite untenable 
on the fundamental principle of socialism. In the first place, 
if a man may rightfully own capital, then, surely, he may 

354 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER, 
without wrong receive the income which capital produces This 
the sociahst admits in admitting that the owner of capital 
devoted to production has a right to receive so much of the 
product as will replace the capital; for surely it would not be 
right, on the socialist principle, to give the capital owner any 
portion of the product unless that portion could properly be 
credited to his capital as being the product of that capital But 
agam, if the owner of capital has a right to what his capital 
produces, then he has a right to its net product, if such there 
be. Accordingly, the whole matter turns on the question whether 
or not capital yields a net product. But on this point, as we 
have explained several times, there can be no serious doubt 
The net productivity of capital can be established just as com- 
pletely as its gross productivity. The decisive proof that cap- 
ital has gross productivity, i. e., produces enough to replace 
Itself, is to be found in the fact that entrepreneurs use bor- 
rowed capital and replace it in full. For they could not replace 
such borrowed capital, unless enough of the joint product were 
properly imputable to said capital; and enough of the joint 
product could not be so imputable, unless the combination into 
which it was put were productive enough to cover the other 
factors in the process and leave something over. Now, pre- 
ciseK sHch a proof can be furnished for the net productivity of 
capital. Entrepreneurs not only replace capital but also pay 
interest. Now, they could not do this unless enough of the 
joint product to cover both these items were properly imputable 
to capital; and enough of the joint product cauld not be so 
imputable, unless the combination into which it was ptit were 
productive enough to cover the other factors in the case and 
leave something over. 

Thus we see that it is not possible to maintain either (1) that 
it is essentially wrong for private persons to own capital, or 
(2) that it is essentially wrong for them to receive a net income 
from capital. There is, therefore, nothing essentially wrong or 
illegitimate in private interest. 

2. The Legitimacy of Private Profits. 
There are no doubt many cases of profits which it would be 
difficult to defend. But profits in general, a return to the per- 
son who assumes the responsibility of cooperative production, 

355 



PRINCIPLES OF ECONOMICS 

this is too plainly reasonable to merit serious discussion. That 
such persons are producers in the sense that they supply a con- 
dition essential to the result is obvious. That they are pro- 
ducers in the sense that to them some portion of the joint prod- 
uct is actually imputed is sufficiently proved by the fact that 
they get profits. (Compare the case of interest above.) But, if 
profits roughly correspond to a product of the entrepreneur, they 
surely can not be condemned as inherently wicked.* 

3. The Marxian Theory of Profits and Interest. 

A natural addendum to the above argument that private in- 
terest and profits are not inherently unreasonable or illegitimate, 
is the refutation of the most important among the theories 
which support the opposite conclusion. It is not too much to 
say that the socialist propaganda of today derives its chief 
power from a particular theory of profits and, through that, from 
a particular theory of value on which said theory of profits is 
based. In an earlier connection, we discussed that theory of 
value — the Labor theory. Here we have to comment upon the 
theory of profits which was built upon that theory of value and 
which has been, and continues to be, one of the most powerful 
weapons of socialism in its attack upon the present order. The 
theory in question is commonly known as the Surplus-Value 
theory or the Exploitation theory. Besides the standard form, 
it appears in one or two popular guises which probably have 
more influence than the original theory. 

A. The Standard Form of the Surplus-Value Theory. 

In order to insure something like an exact understanding of 
the surplus-value theory, I will put the statement of it into a 
series of four formal propositions, as follows: (1) The value 
of the output of any producing unit (factory, railway, etc.) is 
determined by the labor expended upon that output. (2) The 
value, or cost to the employer, of labor power (capacity to give 
off labor services) is determined by the labor necessary to keep 
up the supply of such labor power, produce the living of labor- 
ers. (3) The labor power purchased by the employer is able to 
give off considerably more labor than the amount necessary to 

*It is interesting to note that even Medieval theologians, who 

svveepingly condemned all forms of interest-taking, permitted the taking 

of profits by those who accepted the full responsibilities and risks of an 
enterprise. 

356 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

produce the living of the laborer ; and the employer sees to it 
that the labor power he buys does give off this excess of labor, 
(4) Accordingly, the value of the employer's output is in excess 
of his outlay ; and, so, he gets a surplus which he divides with 
landlords and capitalists, 

To make this more definite, let us work out a concrete illus- 
tration. Let us suppose ihai it costs the labor of one-half day 
to produce the goods commonly considered necessary to support 
a laborer and his family for one da}^, which goods, according 
to the cost theory of wages, must constitute the price of a day of 
labor power, i.e., wages. Let us suppose, again, that to produce 
25.8 grains of gold also costs one half-day of labor, and that 
the law decrees that 25.8 grains of gold shall constitute one 
dollar. Under these conditions, the price of one day of labor 
power, i.e., a day's wages, will be $1. At the same time, since 
the labor of a whole day will produce twice 25.8 grains of gold, 
every day of labor spent on any product will put into that product 
$2 of value. If, now, some entrepreneur buys a day of labor 
power and gets out of it a day's labor in spinning raw cotton 
which has cost him 50 cents, into cotton yarn, that yarn will be 
worth $2.50; i.e., 50 cents due to the cost of the raw cotton and 
$2 because of the day's work put into it.* But the labor power 
which gave the employer a full day's labor and, so, put $2 of 
value into the yarn, actually cost him only $1. Accordingly, he 
finds himself in possession of a surplus of $1. This dollar is 
nis profits. 

There are various criticisms which might be passed on the 
surplus-value theory; but its prime defect is its dependence on 
the erroneous doctrine that value is determined by labor only. 
It attempts to explain the difference between the value of the 
product and the labor power for which the entrepreneur must 
pay — which difference constitutes profits — as due to the fact that 
the labor necessary to produce the entrepreneur's product is 
greater than that necessary to produce the required labor power. 
But, as we learned in Section I, Chapter IX., the labor theory 
of value is quite untenable. Consequently, if there is a reg- 
larly recurring difference between the outlay of the entre- 
preneur and the value of his product, — and of course there must 

*For the sake of simplicity I have ignored wear and tear of ma- 
chinery and other minor expenses. 

357 



PRINCIPLES OF ECONOMICS 

be to give profits — that difference must have some other ex- 
planation. What it is, has been brought out again and again. 
The entrepreneur, in supplying capital (his own or that of some 
one else) and in undertaking the responsibility of production, 
has contributed elements essential to the result, and as these 
elements are not yet supplied in amounts equal to the need for 
them, some portion of the output is credited to them, and, so, 
something less than the whole output is credited to the labor 
required. In consequence, the entrepreneur, who will surely be 
driven by competition to pay for labor substantially the vvhole 
of that portion of the output which is imputable to it, will not, 
after all, be required to pay labor the whole of that output. 

B. In the preceding discussion, we have presented what has 
been called the standard form of the surplus-labor theory. 
Alongside of this standard form, appear one or two interpre- 
tations which are probably more potent in creating sentiment 
against the present order than is the orthodox one. The most 
important of these might be described as the Capital-Monopoly 
theory. While not usually presented in formal fashion, it is 
constantly appearing in socialist writings, even in those of Marx. 
It runs in this wise: In our day, the great development of 
capitalistic methods of production has made it impossible for 
wurkingmen to own the instruments necessary to utilize their 
labor power, so that these have necessarily become the property 
of other persons. But laborers can not get along without these 
instruments, and are, therefore, compelled to accept such terms 
of employment as the owners of those instruments dictate, 
relinquishing a large portion of what they produce as the price 
of having the opportunity to produce at all. Now this method 
of presenting the case is potent as a means of propaganda, and 
it has a plausible sound; but it will not bear the least analysis. 
No class of productive agents can dictate their own terms, unless 
they are organized as a monopoly. But manifestly this not the 
case with capitalists, — entrepreneurs. On the contrary, com- 
petition is very full and free. So long as this continues to be 
true, labor will tend to get all that portion of the joint output 
which is imputable to it as its product. 

4. The Legitimacy of Private Rent 

Among the several private shares into which the social 
income is divided, rent has alwavs been the one with respect to 

358 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

to the legitimacy of which there has been the most serious 
doubt. This does not mean that there has been serious question 
as to the propriety or necessity of there being such a share 
as rent, but only as to the propriety of its going to the persons 
who now receive it. For the position which economists have 
only recently come to take with respect to interest, viz., that it 
is a natural and inevitable element in any economic order, was 
quite early taken with respect to rent. -We can shift the land- 
ing place of rent, but we can not destroy it. Rent, as an ad- 
vantage derived from land and enjoyed by some person or per- 
sons to the exclusion of other persons, save in so far as it is 
arbitrarily redistributed, — rent in this sense can not help existing 
Again, the doubt as to the propriety of the present destination 
of rent does not involve any doubt as to the productivity of the 
land on which rent is received. There can be no question that 
a portion of the product obtained from an industrial combination 
which utilizes a rent-bearing piece of land must be credited to 
said piece as its special product, on any rational system of eco- 
nomic bookkeeping. It follows, then, that, if any man or body 
of men has a valid right to own the land, such man or body of 
men has the right to receive the rent of that land as being the 
product of said land. Accordingly, the crux of the whole mat- 
ter is this: Can private persons acquire a valid title to land? 

In answering the above question in the affirmative, we admit 
at once that it is more difficult to justify private ownership 
in the case of land than in that of capital. The fact that land 
is not, to any considerable degree, a produced good in the ordi- 
nary acceptation of terms, shuts us out in the first instance from 
appealing to the common ethical doctrine that a man has a valid 
title to what he produces.* Doubtless special cases arise in which 
the common moral sentiment would recognize some service of 
discovery and appropriation as sufficiently fulfilling the requi- 
site of productive action to create a title under the ordinary 

*In utilizing as an ethical basis for our discussion the common 
doctrine that production gives a valid claim to goods, I do not wish 
to be understood as holding either (1) that said doctrine is unquali- 
fiedly true,_ or (2) that there is no other valid basis for a property 
right in things. On the contrary, I hold that law can rightfully main- 
tain anv system of_ property rights which is found most conducive to 
the ^ye]fare of society. It seems best, however, in meeting popular 
obiections to the existing order, to argue, in so far as this is possible, 
on the basis of such fundamental principles as are accepted by people 
generally. 

359 



PRINCIPLES OF ECONOMICS 

principle. But such cases are infrequent. Broadly speaking, land 
is not a result of economic production. If, then, a valid title can 
be derived only from production, there can be no valid title to 
land either for the individual or for the state. But it is hardly 
necessary to say that production is not the only adequate basis 
of a valid title. If it wpre^ eronnmic cooperation through ex- 
change, would obviously be impossible : no man could devote 
himself to producing one thing, depending on exchange with 
other persons to supply him with other things. At present, 
such a procedure is possible, because everybody recognizes that, 
in so far as the validity of a man's title to property rests on his 
ozvn action, exchange, carried out in good faith, gives just as 
valid a title as does production.^ The farmer who trades seven 
cords of woods which he has produced for a cutter has now just 
as good a title to the cutter as he did have to the wood; and, 
if he should now trade the cutter for a double harness, he 
would have just as good a title to the harness as he did have to 
the wood. But it is hardly necessary to remark that, in com- 
munities which are two or three generations old and in which 
there is free trade in land, practically all the landholders have 
acquired their landed properties through exchange. It follows, 
therefore, that they have, generally speaking, quite as good titles 
to those properties as they do to the horses, furniture, carriages, 
etc., which they have obtained through exchange. 

Note: In the statement that exchange gives just as valid a 
title as does production, appeared the qualifying phrase : "in 
so lar as the validity of a man's title to property rests on his 
own action." This was necessary to anticipate the objection 
which some would urge that exchange can not give a valid title 
to anything unless the seller himself has one and, besides, has 
the right to transfer his title. Applying this consideration to 
the case before us, they would say (1) that ordmarily the actual 
private owners of land have purchased from other private 
owners, and we can not assume that the titles of these previous 
owners are valid, since this would beg the whole question of 
the validity of private titles to land; and (2) that, if we try 
to meet this difficulty by harking back to grants by the state — 
the only natural or artificial person who can claim a valid title, — 
we have to assume that said state has a right to relinquish its 
title, to alienate its property, — an assumption which they insist is 



*In sr> far, remember, as the goodness of his title depends on him- 
self. 

360 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

quite unwarranted, in that the state's title is that of a trustee 
acting for society as a whole or for men generally. 

It is obvious that the pith of this objection is contained in 
the second part; for, if the original title derived from the state 
were good, the number of subsequent exchanges whether one 
or one hundred would have no bearing on the matter. The 
decisive question, then, is this : Is it reasonable to claim with 
the followers of Heniy George that the state could never right- 
fully alienate its property in land? Surely in this age there can 
be but one answer. The state as the final authority can do 
whatever it believes to be for the highest welfare of society; 
that is, it has the right to alienate its property in land when 
this seems to be the right course, and it has equally the right 
to resume such property when that course comes to be recog- 
nized as the right one. In a word, the social welfare, as inter- 
preted by the highest human authority — the state, is the supreme 
law,_ the supreme right. If a man has done his part toward 
gaining a valid title to land through exchange, he need not give 
himself anxiety lest the original grant of the state was invalid. 

In the preceding discussion, we defended the general validity 
of private titles to land, and, so of private rent, on the ground 
that private landowners have gained their titles through ex- 
change, purchase. Now, the same facts can be interpreted in a 
different way, and, when so interpreted, furnish an even better 
defense of private rent. When a man uses $2,000 to buy a piece 
of ground yielding a net income of $100, he in effect transforms 
that land into capital and its income into interest. Now, I do 
not admit that he literally makes capital of the land or interest 
of the rent. The land is still a different thing from typical 
capital; and, in some very important relations, will continue to 
behave differently and, therefore, will need to be recognised as 
different. But, fur our present needs, land in effect becomes 
capital. For our present needs, the real problem is this : 
What is the nature and origin of the $100 income derived from 
the given piece of land, — said income being looked at from the 
standpoint of the man who buys the land in order to get said 
income. To this question, there is but one answer: from the 
standpoint named, this incom.e is interest. If there were no 
such thing as interest, i.e., if the rate were zero, this income, 
as a net income, would not exist. It is, indeed, true that the 
$100 would still be received by the landowner each year; but, 
then what would that mean as compared with what actually hap- 
pens now? Under the present system, he gets $100 each year for 

361 



PRINCIPLES OF ECONOMICS 

an indefinitely extended series of years ; but, instead of having 
been obliged to pay, for this privilege, an indefinite number of 
times $100, he actually had to pay for it only twenty times $100, 
i.e., $2,000. If, however, there were no such thing as interest, 
though he would still get the $100 each year, he would have 
been obliged to pay for each of these $10O's an exactly equal 
amount, that is, he would have been obliged to pay for the 
right to receive $100 every year for fifty years, fifty times $100, 
i.e., $5,000; or, for that right covering lOO years, one hundred 
times $100, i.e., $10,000; or, for that right covering 20O years, 
two hundred times $100, i.e., $20,000; or, for that right covering 
an indefinite period of years, an indefinite number of times $100. 
In short, he would get no clear income from the land, but, in- 
stead, would get back in an indefinite series of annual instal- 
ments, exactly what he had put into the land in one lump sum. 

The preceding discussion shows that, from the standpoint of 
a landowner who has bought the land, the rent of said land is in 
effect interest. It follows, then, that, if interest, as a type of 
income going to private persons, is legitimate, rent is also. 

But there is still one more objection to be met. The critic of 
the present order may observe that, though, in the course of 
the transaction by which land changes ownership, rent is trans- 
formed into interest, yet this is only a temporary phenomenon. 
That transformation was effected because the value of the land 
adjusted itself to an income determined, net by the natural laivs 
zvhich govern interest, but by those which govern rent. This 
process of adjustment for the moment established a ratio be- 
tween land value and land income exactly the same as that 
which prevails between capital value and capital income. But, 
then, this did not really make rent into^ interest, nor bring it 
under the dominion of the natural laws which govern interest. 
The very next day, something might happen to double, let 
us say, the income from the site, therefore to double its value, 
and, so to give to the owner of the land an income and a 
property to which he could lay no valid claim, whether we 
base such claims on production or exchange. 

Now, the above objection to the legitimacy of private rent 
sounds plausible ; but it is not, after all, difficult to answer. 
Just as an unchanging rent derived from a purchased piece 
of land is in effect interest, so an increase in rent derived 

362 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

from such a piece of land is in effect profits. Nay more, it is 
profits. For, in accepting tlie responsibility of owning said 
piece of land, a man exposes himself to that risk which ac- 
companies all ownership, i.e., the risk of seeing his property 
fall oft" in income and so in value. To induce men to assume 
said risk, it is necessary that there should also be present the 
chance of unexpected increase in income and value. When 
that unexpected increase comes, no new designation is needed 
for it; it is simply a case of profits. If, therefore, profits in 
general constitute a legitimate source of income for private 
persons, there is nothing inherently wrong in the so-called 
unearned increment of rents and land values. 

_ Caution : It is not intended, in the above presentation of 
this matter, to leave the impression that the legitimacy of private 
ownership in the case of land is as clear and certain as in 
some other cases. Wherever the element of chance, accident, 
plays a very great role, there is much to be said in favor of 
public ownership. While speculation performs a real economic 
function, as was brought out in an earlier connection, such 
speculation is in many respects hurtful and demoralizing. A 
socialist state would need it much less than does the present 
order, in that the pooling of all industries would greatly di- 
minish the risk element. Even going no further than to 
assume the control of land would do much to diminish risk and 
its attendant evils. But, whether private or public ownership 
will in the end prove best, of this there can be no doubt, 
there is nothing inherently zvrong in the private ownership of 
land and the private receiving of rent. 

Section F. Further Questions Involved in Determining the 
Legitimacy of the Present System of Distribution. 

In the preceding three sections, we have considered the 
legitimacy of the present system of distribution in respect to 
its main features: the principle which it attempts to realize— 
the service-value principle — and its interpretation of that prin- 
ciple so as to give interest, profits, and rent to private persons. 
Time limits compel us to bring this discussion to a close with- 
out considering various other questions which would need to be 
answered in a truly complete critique of the existing order. We 
will, however, take a moment to call the student's attention to 
those questions without undertaking to answer them. 

1. In Section E, we merely attempted to argue for the 
general^ abstract, legitimacy of interest, profits, and rent as 

363 



PRINCIPLES OF ECONOMICS 

private shares, though admitting that, even if that question were 
answered in the affirmative, there would still remain the ques- 
tion whether under the conditions actually prevailing, with all 
the known weaknesses of human nature, the shares named can 
legitimately go to private persons. We recognize this question 
to be a really serious one. We see much force in the conten- 
tion that, however reasonable it may be on general principles 
to permit the private ownership of capital and land and the 
private undertaking of industry, the evils which inevitably result 
from such a policy in the actual working of things make its 
continuance impossible of justification. But, although admitting 
the force of this consideration, still, in view of the great 
superiority, in other respects, of private, to public, ownership, 
and in view of the fact that its worst evils can be gradually 
removed without overturning the system, we believe that the 
system of private ownership should be maintained. At the same 
time, however, we believe that regulation of private initiative 
should be carried much further than it has been, that the lim- 
itations of the property right should be increased, and that at 
some points, how many and what only experience will show, 
public ownership and initiative should he substituted for private. 

2. A second supplemental question of much importance is 
whether the present system is justified in permitting private 
individuals to acquire possessions through inheritance or be- 
quest. Personally, I am disposed to answer this question in the 
affirmative but only with very emphatic qualifications. I would 
greatly reduce these rights both directly by legislation and 
indirectly by a taxation which for the excess of larger estates 
over a certain minimum would amount to practical confiscation. 

3. Still another question which a fuller treatment would 
attempt to answer is as to whether law should permit private 
persons to enjoy the extraordinary profits which flow from 
the exploitation of natural resources, public franchises, con- 
solidations, etc. It seems very doubtful ; but the question is too 
large for a paragraph. 

4. Finally, one of the most important questions which must 
be left unanswered is this : How far can society afford to 
modify the primary distribution of property and income through 
a secondary distribution effected by taxation? For it would 

364 



CHAPTER XIII. CRITIQUE OF PRESENT ORDER. 

seem plain that, if the dominance of the present principle of 
distribution — to each in accord with the value of his services — 
is necessary to insure the proper conduct of economic affairs, 
we should spoil everything by arbitrarily contravening the 
working of that principle, even though we do this after dis- 
tribution in accord zvith the principle has once been effected. 
For what interest would a man have in earning ten times as 
much as his fellows, if he is to be reduced to their level by 
taxation? Doubtless, if it were to go so far as this, he would 
have no interest in seeking the better income. But, on the other 
hand, there can be no doubt that a tax much heavier than that 
levied on his poorer neighbor would not influence in any material 
degree his economic efficiency. The whole problem is one of 
degrees. Probably its solution is possible only through experi- 
ment. In any case we shall have to be satisfied with merely 
suggesting it. 



365 



l%k 



One copy del. to Cat. Div. 



OCT io 19/1 



